BOOK
LESSON 1: STANDARD 1:
PROFESSIONALISM
Knowledge of the Law B.
Independence and Objectivity
c. Misrepresentation
D. Misconduct
LOS 3a: Demonstrate the application of the Code of
Ethics and Standards of Professional Conduct to situations involving issues of
professional integrity. vol 1, pp 55-208
LOS 3b: Distinguish between conduct that conforms to the Code
and
Standards and conduct that violates the Code and Standards.
vol 1, pp 55-208
LOS 3c: Recommend practices and procedures designed to
prevent violations of the Code of Ethics and Standards of Professional
Conduct.vol 1, pp 55-208
Standard I(A): Knowledge of
the Law
LESSON 1: STANDARD 1:
PROFESSIONALISM
Knowledge of the Law B.
Independence and Objectivity
c. Misrepresentation
D. Misconduct
LOS 3a: Demonstrate the application of the Code of
Ethics and Standards of Professional Conduct to situations involving issues of
professional integrity. vol 1, pp 55-208
LOS 3b: Distinguish between conduct that conforms to the Code
and
Standards and conduct that violates the Code and Standards.
vol 1, pp 55-208
LOS 3c: Recommend practices and procedures designed to
prevent violations of the Code of Ethics and Standards of Professional
Conduct.vol 1, pp 55-208
Standard I(A): Knowledge of
the Law
The Standard
Members and candidates must understand and comply with all applicable laws,
rules, and regulations (including the CFA Institute Code of Ethics and
Standards of Professional Conduct) of any government, regulatory organization,
licensing agency, or professional association governing their professional activities.
In the event of conflict, members and candidates must comply with the more
strict law, rule, or regulation. Members and candidates must not knowingly
participate or assist in and must dissociate from any violation of such laws,
rules, or regulations.
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Members and candidates must understand and comply with all applicable laws,
rules, and regulations (including the CFA Institute Code of Ethics and
Standards of Professional Conduct) of any government, regulatory organization,
licensing agency, or professional association governing their professional activities.
In the event of conflict, members and candidates must comply with the more
strict law, rule, or regulation. Members and candidates must not knowingly
participate or assist in and must dissociate from any violation of such laws,
rules, or regulations.
Guidance
•
Members and candidates must
understand the applicable laws and regulations of the countries and
jurisdictions where they engage in professional activities. 
On the basis of their reasonable and good
faith understanding, members and candidates must comply with the laws and
regulations that directly govern their professional activities and resulting
outcomes and that protect the interests of the clients. 
When questions arise, members and candidates
should know their firm's policies and procedures for accessing compliance
guidance.
•
During times of changing
regulations, members and candidates must remain vigilant in maintaining their
knowledge of the requirements for their professional activities.
•
Members and candidates must
understand the applicable laws and regulations of the countries and
jurisdictions where they engage in professional activities. On the basis of their reasonable and good
faith understanding, members and candidates must comply with the laws and
regulations that directly govern their professional activities and resulting
outcomes and that protect the interests of the clients. When questions arise, members and candidates
should know their firm's policies and procedures for accessing compliance
guidance.
•
During times of changing
regulations, members and candidates must remain vigilant in maintaining their
knowledge of the requirements for their professional activities.
Relationship between the Code and Standards and
Applicable Law
When applicable law and the Code and Standards
require different conduct, members and candidates must follow the stricter of
the applicable law or the Code and Standards.
"Applicable law" is the law that
governs the member's or candidate's conduct. Which law applies will depend on
the particular facts and circumstances of each case.
The "more strict" law or regulation
is the law or regulation that imposes greater restrictions on the action of the
member or candidate, or calls for the member or candidate to exert a greater
degree of action that protects the interests of investors.
Global Application of
the Code and Standards
Members and candidates
who practice in multiple jurisdictions may be subject to varied securities laws
and regulations. The following chart provides illustrations involving a member
who may be subject to the securities laws and regulations of three different
types of countries:
NS: country
with no securities laws or regulations
IS: country
with less strict securities laws and regulations than and Standards
MS; country with more stnCt seCuntlCS laws and regulations than the
C'_xåe and Standards
Applicable Law Duties Explanation
When applicable law and the Code and Standards
require different conduct, members and candidates must follow the stricter of
the applicable law or the Code and Standards.
"Applicable law" is the law that
governs the member's or candidate's conduct. Which law applies will depend on
the particular facts and circumstances of each case.
The "more strict" law or regulation
is the law or regulation that imposes greater restrictions on the action of the
member or candidate, or calls for the member or candidate to exert a greater
degree of action that protects the interests of investors.
Global Application of
the Code and Standards
Members and candidates
who practice in multiple jurisdictions may be subject to varied securities laws
and regulations. The following chart provides illustrations involving a member
who may be subject to the securities laws and regulations of three different
types of countries:
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NS: country
with no securities laws or regulations IS: country
with less strict securities laws and regulations than and Standards MS; country with more stnCt seCuntlCS laws and regulations than the
C'_xåe and Standards |
Applicable Law Duties Explanation
Member resides in NS
country, does business in LS country; IS law applies.
Member resides in NS
country, does business in MS country; MS law applies.
Member resides in LS
country, does business in NS country; LS law applies.
Member resides in LS
country, does business in MS country; MS law applies.
Member resides in LS country, does business in NS
country; LS law applies, but it states that law of locality where business is
conducted governs.
Member resides in LS country, does business in MS
country; LS law applies, but it states that law of locality where business is
conducted governs.
Member resides in MS country, does business in IS
country; MS law applies.
Member must adhere to the
Code and Standards.
Member must adhere to the
law of MS country.
Member must adhere to the
Code and Standards.
 |
Member must adhere to the law of MS country.
Member must adhere to the
Code and Standards.
Member must adhere to the
law of MS country.
Member must adhere to the
law of MS country.
Because applicable law is less strict than the Code and
Standards, the member must adhere to the Code and Standards.
Because applicable law is
stricter than the Code and Standards, member must adhere to the more strict
applicable law.
Because applicable law is
less strict than the Code and Standards, member must adhere to the Code and
Standards.
Because applicable law is stricter than the
Code and Standards, member must adhere to the more strict applicable law.
Because applicable law
states that the law of the locality where the business is conducted governs and
there is no local law, the member must adhere to the Code and Standards.
Because applicable law of the locality where the
business is conducted govems and local law is stricter than the Code and Standards,
member must adhere to the more strict applicable law.
Because applicable law is stricter than the
Code and Standards, member must adhere to the more strict applicable law.
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Applicable Law |
Duties |
Explanation |
|
Member resides in MS country, does business in IS country;
MS law applies, but it states that law of locality where business is
conducted governs. Member resides in MS country, does business in LS country
with a client who is a citizen of LS country; MS law applies, but it states
that the law of the client's home country governs. Member resides in MS country, does
business in IS country with a client who is a citizen of MS country; MS law
applies, but it states that the law of the client's home country governs. |
Member must
adhere to the Code and Standards. Member must
adhere to the Code and Standards. Member must adhere to the law of MS country. |
Because applicable
law states that the law of the locality where the business is conducted
governs and local law is less strict than the Code and Standards, member must
adhere to the Code and Standards. Because applicable law
states that the law of the client's home country governs (which is less
strict than the Code and Standards), member must adhere to the Code and
Standards. Because applicable law states that the law of the
client's home country governs and the law of the client's home country is
stricter than the Code and Standards, the member must adhere to the more
strict applicable law. |
Participation in or
Association with Violations by Others
•
Members and candidates are
responsible for violations in which they knowingly participate or assist.
Standard I(A) applies when members and candidates know or should know that
their conduct may contribute to a violation of applicable laws, rules, or
regulations or the Code and Standards.
•
If a member or candidate
has reasonable grounds to believe that imminent or ongoing client or employer
activities are illegal or unethical, the member or candidate must dissociate,
or separate, from the activity.
•
 |
In extreme cases, dissociation may require a member or candidate to leave his
or her employment.
•
Members and candidates may
take the following intermediate steps to dissociate from ethical violations of
others when direct discussions with the person or persons committing the
violation are unsuccessful.
•
Attempt to stop the
behavior by bringing it to the attention of the employer through a supervisor
or the firm's compliance department.
If this attempt is unsuccessful, then members
and candidates have a responsibility to step away and dissociate from the
activity. Inaction combined with continuing association with those involved in
illegal or unethical conduct may be construed as participation or assistance in
the illegal or unethical conduct.
•
CFA Institute strongly
encourages members and candidates to report potential violations of the Code
and Standards committed by fellow members and candidates, although a failure to
report is less likely to be construed as a violation than a failure to
dissociate from unethical conduct.
Investment Products and
Applicable Laws
•
Members and candidates
involved in creating or maintaining investment services or investment products
or packages of securities and/or derivatives should be mindful of where these
products or packages will be sold as well as their places of origination.
•
They should understand the
applicable laws and regulations of the countries or regions of origination and
expected sale, and should make reasonable efforts to review whether associated
firms that are distributing products or services developed by their employing
firms also abide by the laws and regulations of the countries and regions of
distribution.
•
Finally, they should
undertake the necessary due diligence when transacting crossborder business to
understand the multiple applicable laws and regulations in order to protect the
reputation of their firms and themselves.
Recommended Procedures
for Compliance
Members and Candidates
 |
Suggested methods by which members and candidates can acquire and maintain
understanding of applicable laws, rules, and regulations include the following:
•
Stay informed: Members and
candidates should establish or encourage their employers to establish a
procedure by which employees are regularly informed about changes in applicable
laws, rules, regulations, and case law.
•
Review procedures: Members
and candidates should review, or encourage their employers to review, the
firm's written compliance procedures on a regular basis to ensure that the
procedures reflect current law and provide adequate guidance to employees about
what is permissible conduct under the law and/or the Code and Standards.
•
Maintain current files:
Members and candidates should maintain or encourage their employers to maintain
readily accessible current reference copies of applicable statutes, rules,
regulations, and important cases.
Distribution Area Laws
•
Members and candidates
should make reasonable efforts to understand the applicable laws—both country
and regional—for the countries and regions where their investment products are
developed and are most likely to be distributed to clients.
Legal Counsel
•
When in doubt about the
appropriate action to undertake, it is recommended that a member or candidate
seek the advice of compliance personnel or legal counsel concerning legal
requirements.
•
If a potential violation is
being committed by a fellow employee, it may also be prudent for the member or
candidate to seek the advice of the firm's compliance department or legal
counsel.
Dissociation
•
When dissociating from an
activity that violates the Code and Standards, members and candidates should
document the violation and urge their firms to attempt to persuade the
perpetrator(s) to cease such conduct. Note that in order to dissociate from the
conduct, a member or candidate may have to resign his or her employment.
Firms
Members and candidates
should encourage their firms to consider the following policies and procedures
to support the principles of Standard I(A):
•
Develop and/or adopt a code
of ethics.
•
Provide information on
applicable laws.
•
Establish procedures for
reporting violations.
Application of the
Standard
Example 1 (Notification of Known
Violations)
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Michael Allen works for a brokerage firm and is responsible for an underwriting
of securities. A company official gives Allen information indicating that the
financial statements Allen filed with the regulator overstate the issuer's
earnings. Allen seeks the advice of the brokerage firm's general counsel, who
states that it would be difficult for the regulator to prove that Allen has
been involved in any wrongdoing.
Comment: Although it is
recommended that members and candidates seek the advice of legal counsel, the
reliance on such advice does not absolve a member or candidate from the
requirement to comply with the law or regulation. Allen should report this
situation to his supervisor, seek an independent legal opinion, and determine
whether the regulator should be notified of the error.
Example 2 (Dissociating from a
Violation)
Lawrence Brown 's employer, an
investment banking firm, is the principal underwriter for an issue of
convertible debentures by the Courtney Company. Brown discovers that the
Courtney Company has concealed severe third-quarter losses in its foreign
operations. The preliminary prospectus has already been distributed.
Comment: Knowing that the
preliminary prospectus is misleading, Brown should report his findings to the
appropriate supervisory persons in his firm. If the matter is not remedied and
Brown's employer does not dissociate from the underwriting, Brown should sever
all his connections with the underwriting. Brown should also seek legal advice
to determine whether additional reporting or other action should be taken.
Example 3 (Following the Highest Requirements)
Laura Jameson works for a multinational investment adviser
based in the United States. Jameson lives and works as a registered investment
adviser in the tiny, but wealthy, island nation of Karramba. Karramba's
securities laws state that no investment adviser registered and working in that
country can participate in initial public offerings (IPOs) for the adviser's
personal account. Jameson, believing that, as a U.S. citizen working for a
U.S.—based company, she should comply only with U.S. law, has ignored this
Karrambian law. In addition, Jameson believes that as a charterholder, as long
as she adheres to the Code and Standards requirement that she disclose her
participation in any IPO to her employer and clients when such ownership
creates a conflict of interest, she is meeting the highest ethical
requirements.
Comment: Jameson is in violation of Standard I(A). As a
registered investment adviser in Karramba, Jameson is prevented by Karrambian
securities law from participating in IPOs regardless of the law of her home
country. In addition, because the law of the country where she is working is
stricter than the Code and Standards, she must follow the stricter requirements
of the local law rather than the requirements of the Code and Standards.
Example 4 (Reporting Potential Unethical Actions)
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Krista
Blume is a junior portfolio manager for high-net-worth portfolios at a large
global investment manager. She observes a number of new portfolios and
relationships coming from a country in Europe where the firm did not have
previous business and is told that a broker in that country is responsible for
this new business. At a meeting on allocation of research resources to
third-party research firms, Blume notes that this broker has been added to the
list and is allocated payments for research. However, she knows the portfolios
do not invest in securities in the broker's country, and she has not seen any
research come from this broker. Blume asks her supervisor about the name being
on the list and is told that someone in marketing is receiving the research and
that the name being on the list is OK. She believes that what may be going on
is that the broker is being paid for new business through the inappropriate
research payments, and she wishes to dissociate from the misconduct.
Comment: Blume should follow the firm's policies and
procedures for reporting potential unethical activity, which may include
discussions with her supervisor or someone in a designated compliance
department. She should communicate her concerns appropriately while advocating
for disclosure between the new broker relationship and the research payments.
Example 5 (Failure to Maintain Knowledge of the Law)
Colleen White is excited to use new technology to communicate
with clients and potential clients. She recently began posting investment
information, including performance reports and investment opinions and
recommendations, to her Facebook page. In addition, she sends out brief
announcements, opinions, and thoughts via her Twitter account (for example,
"Prospects for future growth of XYZ company look good!
#makingmoney4U"). Prior to White's use of these social media platforms,
the local regulator had issued new requirements and guidance governing online
electronic communication. White's communications appear to conflict with the
recent regulatory announcements.
Comment: White is in violation of Standard I(A) because her
communications do not comply with the existing guidance and regulation
governing use of social media. White must be aware of the evolving legal
requirements pertaining to new and dynamic areas of the financial services
industry that are applicable to her. She should seek guidance from appropriate,
knowledgeable, and reliable sources, such as her firm's compliance department,
external service providers, or outside counsel, unless she diligently follows
legal and regulatory trends affecting her professional responsibilities.
Standard I(B) Independence
and Objectivity
The Standard
Members and candidates
must use reasonable care and judgment to achieve and maintain independence and
objectivity in their professional activities. Members and candidates 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.
Guidance
•
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Members and candidates should endeavor to avoid situations that could cause or
be perceived to cause a loss of independence or objectivity in recommending
investments or taking investment action.
•
Modest gifts and
entertainment are acceptable, but special care must be taken by members and
candidates to resist subtle and not-so-subtle pressures to act in conflict with
the interests of their clients. Best practice dictates that members and
candidates reject any offer of gift or entertainment that could be expected to
threaten their independence and objectivity.
•
Receiving a gift, benefit,
or consideration from a client can be distinguished from gifts given by
entities seeking to influence a member or candidate to the detriment of other
clients.
•
When possible, prior to
accepting "bonuses" or gifts from clients, members and candidates
should disclose to their employers such benefits offered by clients. If
notification is not possible prior to acceptance, members and candidates must
disclose to their employer benefits previously accepted from clients. 
Members and candidates are personally responsible for
maintaining independence and objectivity when preparing research reports,
making investment recommendations, and taking investment action on behalf of
clients. Recommendations must convey the member's or candidate's true opinions,
free of bias from internal or external pressures, and be stated in clear and
unambiguous language.
•
When seeking corporate
financial support for conventions, seminars, or even weekly society luncheons,
the members or candidates responsible for the activities should evaluate both
the actual effect of such solicitations on their independence and whether their
objectivity might be perceived to be compromised in the eyes of their clients.
Investment Banking
Relationships
•
Some sell-side firms may
exert pressure on their analysts to issue favorable research reports on current
or prospective investment banking clients. Members and candidates must not
succumb to such pressures.
•
Allowing analysts to work
with investment bankers is appropriate only when the conflicts are adequately
and effectively managed and disclosed. Firm managers have a responsibility to
provide an environment in which analysts are neither coerced nor enticed into
issuing research that does not reflect their true opinions.
Firms should require public disclosure of actual
conflicts of interest to investors. 
Any "firewalls" between the
investment banking and research functions must be managed to minimize conflicts
of interest. Key elements of enhanced firewalls include: 
Separate reporting structures for personnel on
the research side and personnel on the investment banking side.
•
Compensation arrangements
that minimize pressures on research analysts and reward objectivity and
accuracy.
Public Companies
•
Analysts may be pressured
to issue favorable reports and recommendations by the companies they follow. In
making an investment recommendation, the analyst is responsible for
anticipating, interpreting, and assessing a company's prospects and stock price
performance in a factual manner.
•
 |
Due diligence in financial research and analysis involves gathering information
from a wide variety of sources, including public disclosure documents (such as
proxy statements, annual reports, and other regulatory filings) and also
company management and investor-relations personnel, suppliers, customers,
competitors, and other relevant sources. Research analysts may justifiably fear
that companies will limit their ability to conduct thorough research by denying
analysts who have "negative" views direct access to company managers
and/or barring them from conference calls and other communication venues. This
concern may make it difficult for them to conduct the comprehensive research
needed to make objective recommendations.
Buy-Side Clients
•
Portfolio managers may have
significant positions in the security of a company under review. A rating
downgrade may adversely affect the portfolio's performance, particularly in the
short term, because the sensitivity of stock prices to ratings changes has
increased in recent years. A downgrade may also affect the manager's
compensation, which is usually tied to portfolio performance. Moreover,
portfolio performance is subject to media and public scrutiny, which may affect
the manager's professional reputation. Consequently, some portfolio managers
implicitly or explicitly support sell-side ratings inflation.
•
Portfolio managers have a
responsibility to respect and foster the intellectual honesty of sell-side
research. Therefore, it is improper for portfolio managers to threaten or
engage in retaliatory practices, such as reporting sell-side analysts to the
covered company in order to instigate negative corporate reactions.
Fund Manager and Custodial
Relationships
•
Research analysts are not
the only people who must be concerned with maintaining their independence.
Members and candidates who are responsible for hiring and retaining outside
managers and third-party custodians should not accepts gifts, entertainment, or
travel funding that may be perceived as impairing their decisions.
Credit Rating Agency
Opinions
•
Members and candidates
employed at rating agencies should ensure that procedures and processes at the
agencies prevent undue influences from a sponsoring company during the
analysis. Members and candidates should abide by their agencies' and the
industry's standards of conduct regarding the analytical process and the
distribution of their reports.
•
When using information
provided by credit rating agencies, members and candidates should be mindful of
the potential conflicts of interest. And because of the potential conflicts,
members and candidates may need to independently validate the rating granted.
Issuer-Paid Research
•
Some companies hire
analysts to produce research reports in case of lack of coverage from sell-side
research, or to increase the company's visibility in financial markets. 
Analysts must engage in thorough, independent,
and unbiased analysis and must fully disclose potential conflicts, including
the nature of their compensation. It should also be clearly mentioned in the
report that the research has been paid for by the subject company. At a
minimum, research should include a thorough analysis of the company's financial
statements based on publicly disclosed information, benchmarking within a peer
group, and industry analysis.
•
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Analysts must try to limit the type of compensation they accept for conducting
research. This compensation can be direct, such as payment based on the
conclusions of the report, or more indirect, such as stock warrants or other
equity instruments that could increase in value based on positive coverage in
the report. In those instances, analysts would have an incentive to avoid
negative information or conclusions that would diminish their potential
compensation.
•
Best practice is for
analysts to accept only a flat fee for their work prior to writing the report,
without regard to their conclusions or the report's recommendations.
Travel Funding
•
The benefits related to
accepting paid travel extend beyond the cost savings to the member or candidate
and his firm, such as the chance to talk exclusively with the executives of a
company or learning more about the investment options provided by an investment
organization. Acceptance also comes with potential concerns; for example,
members and candidates may be influenced by these discussions when flying on a
corporate or chartered jet, or attending sponsored conferences where many
expenses, including airfare and lodging, are covered.
•
To avoid the appearance of
compromising their independence and objectivity, best practice dictates that
analysts always use commercial transportation at their expense or at the
expense of their firm rather than accept paid travel arrangements from an
outside company.
•
In case of unavailability
of commercial travel, they may accept modestly arranged travel to participate
in appropriate information gathering events, such as a property tour.
Performance Measurement and
Attribution
•
Members and candidates
working within a firm's investment performance measurement department may also
be presented with situations that challenge their independence and objectivity.
As performance analysts, their analyses may reveal instances where managers may
appear to have strayed from their mandate. Additionally, the performance
analyst may receive requests to alter the construction
of composite indices
owing to negative results for a selected account or fund. Members or candidates
must not allow internal or external influences to affect their independence and
objectivity as they faithfully complete their performance calculation and
analysis-related responsibilities.
Influence during the Manager
Selection/Procurement Process
•
When serving in a hiring
capacity, members and candidates should not solicit gifts, contributions, or
other compensation that may affect their independence and objectivity.
Solicitations do not have to benefit members and candidates personally to
conflict with Standard I(B). Requesting contributions to a favorite charity or
political organization may also be perceived as an attempt to influence the
decision-making process. Additionally, members and candidates serving in a
hiring capacity should refuse gifts, donations, and other offered compensation
that may be perceived to influence their decision-making process.
•
When working to earn a new
investment allocation, members and candidates should not offer gifts,
contributions, or other compensation to influence the decision of the hiring representative.
The offering of these items with the intent to impair the independence and
objectivity of another person would not comply with Standard I(B). Such
prohibited actions may include offering donations to a charitable organization
or political candidate referred by the hiring representative.
Recommended Procedures
for Compliance
 |
Members and candidates should adhere to the following practices and should
encourage their firms to establish procedures to avoid violations of Standard
I(B):
•
Protect the integrity of
opinions: Members, candidates, and their firms should establish policies
stating that every research report concerning the securities of a corporate
client should reflect the unbiased opinion of the analyst.
•
Create a restricted list:
If the firm is unwilling to permit dissemination of adverse opinions about a
corporate client, members and candidates should encourage the firm to remove
the controversial company from the research universe and put it on a restricted
list so that the firm disseminates only factual information about the company.
•
Restrict special cost
arrangements: When attending meetings at an issuer's headquarters, members and
candidates should pay for commercial transportation and hotel charges. No
corporate issuer should reimburse members or candidates for air transportation.
Members and candidates should encourage issuers to limit the use of corporate
aircraft to situations in which commercial transportation is not available or
in which efficient movement could not otherwise be arranged.
•
Limit gifts: Members and
candidates must limit the acceptance of gratuities and/or gifts to token items.
Standard I(B) does not preclude customary, ordinary businessrelated
entertainment as long as its purpose is not to influence or reward members or
candidates. Firms should consider a strict value limit for acceptable gifts
that is based on the local or regional customs and should address whether the
limit is per gift or an aggregate annual value.
•
Restrict investments:
Members and candidates should encourage their investment firms to develop formal
polices related to employee purchases of equity or equityrelated IPOs. Firms
should require prior approval for employee participation in IPOs, with prompt
disclosure of investment actions taken following the offering. Strict limits
should be imposed on investment personnel acquiring securities in private
placements.
•
Review procedures: Members
and candidates should encourage their firms to implement effective supervisory
and review procedures to ensure that analysts and portfolio managers comply
with policies relating to their personal investment activities.
•
Independence policy:
Members, candidates, and their firms should establish a formal written policy
on the independence and objectivity of research and implement reporting
structures and review procedures to ensure that research analysts do not report
to and are not supervised or controlled by any department of the firm that
could compromise the independence of the analyst. 
Appointed officer: Firms should appoint a senior officer with
oversight responsibilities for compliance with the firm's code of ethics and
all regulations concerning its business.
Application of the
Standard
Example 1
(Research Independence and Intrafirm Pressure)
Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining
industry. He has concluded that the stock of Metals & Mining is overpriced
at its current level, but he is concerned that a negative research report will
hurt the good relationship between Metals & Mining and the investment
banking division of his firm. In fact, a senior manager of Hilton Brokerage has
just sent him a copy of a proposal his firm has made to Metals & Mining to
underwrite a debt offering. Fritz needs to produce a report right away and is
concerned about issuing a less-than-favorable rating.
Comment: Fritz's analysis of Metals & Mining must be
objective and based solely on consideration of company fundamentals. Any
pressure from other divisions of his firm is inappropriate. This conflict could
have been eliminated if, in anticipation of the offering, Hilton Brokerage had
placed Metals & Mining on a restricted list for its sales force.
Example 2 (Research Independence
and Issuer Relationship Pressure)
As in Example l , Walter Fritz has
concluded that Metals & Mining stock is overvalued at its current level,
but he is concerned that a negative research report might jeopardize a close
rapport that he has nurtured over the years with Metals & Mining's CEO,
chief finance officer, and investment relations officer. Fritz is concerned
that a negative report might result also in management retaliation—for
instance, cutting him off from participating in conference calls when a
quarterly earnings release is made, denying him the ability to ask questions on
such calls, and/or denying him access to top management for arranging group
meetings between Hilton Brokerage clients and top Metals & Mining managers.
Comment: As in Example l , Fritz's
analysis must be objective and based solely on consideration of company
fundamentals. Any pressure from Metals & Mining is inappropriate. Fritz
should reinforce the integrity of his conclusions by stressing that his
investment recommendation is based on relative valuation, which may include
qualitative issues with respect to Metals & Mining's management.
|
Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining
industry. He has concluded that the stock of Metals & Mining is overpriced
at its current level, but he is concerned that a negative research report will
hurt the good relationship between Metals & Mining and the investment
banking division of his firm. In fact, a senior manager of Hilton Brokerage has
just sent him a copy of a proposal his firm has made to Metals & Mining to
underwrite a debt offering. Fritz needs to produce a report right away and is
concerned about issuing a less-than-favorable rating.
Comment: Fritz's analysis of Metals & Mining must be
objective and based solely on consideration of company fundamentals. Any
pressure from other divisions of his firm is inappropriate. This conflict could
have been eliminated if, in anticipation of the offering, Hilton Brokerage had
placed Metals & Mining on a restricted list for its sales force.
Example 2 (Research Independence
and Issuer Relationship Pressure)
As in Example l , Walter Fritz has
concluded that Metals & Mining stock is overvalued at its current level,
but he is concerned that a negative research report might jeopardize a close
rapport that he has nurtured over the years with Metals & Mining's CEO,
chief finance officer, and investment relations officer. Fritz is concerned
that a negative report might result also in management retaliation—for
instance, cutting him off from participating in conference calls when a
quarterly earnings release is made, denying him the ability to ask questions on
such calls, and/or denying him access to top management for arranging group
meetings between Hilton Brokerage clients and top Metals & Mining managers.
Comment: As in Example l , Fritz's
analysis must be objective and based solely on consideration of company
fundamentals. Any pressure from Metals & Mining is inappropriate. Fritz
should reinforce the integrity of his conclusions by stressing that his
investment recommendation is based on relative valuation, which may include
qualitative issues with respect to Metals & Mining's management.
Example 3 (Gifts
and Entertainment from Related Party)
Edward Grant
directs a large amount of his commission business to a New York—based brokerage
house. In appreciation for all the business, the brokerage house gives Grant
two tickets to the World Cup in South Africa, two nights at a nearby resort,
several meals, and transportation via limousine to the game. Grant fails to
disclose receiving this package to his supervisor.
Comment: Grant has violated Standard I(B) because accepting
these substantial gifts may impede his independence and objectivity. Every member
and candidate should endeavor to avoid situations that might cause or be
perceived to cause a loss of independence or objectivity in recommending
investments or taking investment action. By accepting the trip, Grant has
opened himself up to the accusation that he may give the broker favored
treatment in return.
Edward Grant
directs a large amount of his commission business to a New York—based brokerage
house. In appreciation for all the business, the brokerage house gives Grant
two tickets to the World Cup in South Africa, two nights at a nearby resort,
several meals, and transportation via limousine to the game. Grant fails to
disclose receiving this package to his supervisor.
Comment: Grant has violated Standard I(B) because accepting
these substantial gifts may impede his independence and objectivity. Every member
and candidate should endeavor to avoid situations that might cause or be
perceived to cause a loss of independence or objectivity in recommending
investments or taking investment action. By accepting the trip, Grant has
opened himself up to the accusation that he may give the broker favored
treatment in return.
Example 4 (Gifts
and Entertainment from Client)
Theresa Green manages the portfolio of Ian Knowlden, a client
of Tisbury Investments. Green achieves an annual return for Knowlden that is
consistently better than that of the benchmark she and the client previously
agreed to. As a reward, Knowlden offers Green two tickets to Wimbledon and the
use of Knowlden's flat in London for a week. Green discloses this gift to her
supervisor at Tisbury.
Comment: Green is in compliance with Standard I(B) because she disclosed the
gift from one of her clients in accordance with the firm's policies. Members
and candidates may accept bonuses or gifts from clients as long as they
disclose them to their employer because gifts in a client relationship are
deemed less likely to affect a member's or candidate's objectivity and
independence than gifts in other situations. Disclosure is required, however,
so that supervisors can monitor such situations to guard against employees
favoring a gift-giving client to the detriment of other fee-paying clients
(such as by allocating a greater proportion of IPO stock to the gift-giving
client's portfolio).
Best practices for monitoring include comparing the
transaction costs of the Knowlden account with the costs of other accounts
managed by Green and other similar accounts within Tisbury. The supervisor
could also compare the performance returns with the returns of other clients
with the same mandate. This comparison will assist in determining whether a
pattern of favoritism by Green is disadvantaging other Tisbury clients or the
possibility that this favoritism could affect her future behavior.
Example 5 (Research Independence and Compensation
Arrangements)
Javier Herrero recently left his job as a research analyst for
a large investment adviser. While looking for a new position, he was hired by
an investor-relations firm to write a research report on one of its clients, a
small educational software company. The investorrelations firm hopes to
generate investor interest in the technology company. The firm will pay Herrero
a flat fee plus a bonus if any new investors buy stock in the company as a
result of Herrero's report.
Comment: If Herrero accepts this payment arrangement, he will
be in violation of Standard I(B) because the compensation arrangement can
reasonably be expected to compromise his independence and objectivity. Herrero
will receive a bonus for attracting investors, which provides an incentive to
draft a positive report regardless of the facts and to ignore or play down any
negative information about the company. Herrero should accept only a flat fee
that is not tied to the conclusions or recommendations of the report.
Issuer-paid research that is objective and unbiased can be done under the right
circumstances as long as the analyst takes steps to maintain his or her
objectivity and includes in the report proper disclosures regarding potential
conflicts of interest.
Example 6 (Influencing Manager Selection Decisions)
Adrian Mandel, CFA, is a senior portfolio manager for ZZYY Capital Management
who oversees a team of investment professionals who manage labor union pension
funds. A few years ago, ZZYY sought to win a competitive asset manager search
to manage a significant allocation of the pension fund of the United Doughnut
and Pretzel Bakers Union (UDPBU). UDPBU's investment board is chaired by a
recognized key decision maker and longtime leader of the union, Ernesto Gomez.
To improve ZZYY's chances of winning the competition, Mandel made significant
monetary contributions to Gomez's union reelection campaign fund. Even after
ZZYY was hired as a primary manager of the pension, Mandel believed that his
firm's position was not secure. Mandel continued to contribute to Gomez's
reelection campaign chest as well as to entertain lavishly the union leader and
his family at top restaurants on a regular basis. All of Mandel's outlays were
routinely handled as marketing expenses reimbursed by ZZYY's expense accounts
and were disclosed to his senior management as being instrumental in
maintaining a strong close relationship with an important client.
Comment: Mandel not only offered but actually gave monetary
gifts, benefits, and other considerations that reasonably could be expected to
compromise Gomez's objectivity. Therefore, Mandel was in violation of Standard
I(B).
Example 7 (Influencing Manager
Selection Decisions)
Adrian Mandel, CFA, had heard
about the manager search competition for the UDPBU Pension Fund through a
broker/dealer contact. The contact told him that a well-known retired
professional golfer, Bobby "The Bear" Finlay, who had become a
licensed broker/ dealer serving as a pension consultant, was orchestrating the
UDPBU manager search. Finlay had gained celebrity status with several labor
union pension fund boards by entertaining their respective board members and
regaling them with colorful stories of fellow pro golfers' antics in clubhouses
around the world. Mandel decided to improve ZZYY's chances of being invited to
participate in the search competition by befriending Finlay to curry his favor.
Knowing Finlay's love of entertainment, Mandel wined and dined Finlay at
high-profile bistros where Finlay could glow in the fan recognition lavished on
him by all the other patrons. Mandel's endeavors paid off handsomely when
Finlay recommended to the UDPBU board that ZZYY be entered as one of three
finalist asset management firms in its search.
Theresa Green manages the portfolio of Ian Knowlden, a client
of Tisbury Investments. Green achieves an annual return for Knowlden that is
consistently better than that of the benchmark she and the client previously
agreed to. As a reward, Knowlden offers Green two tickets to Wimbledon and the
use of Knowlden's flat in London for a week. Green discloses this gift to her
supervisor at Tisbury.
|
Comment: Green is in compliance with Standard I(B) because she disclosed the
gift from one of her clients in accordance with the firm's policies. Members
and candidates may accept bonuses or gifts from clients as long as they
disclose them to their employer because gifts in a client relationship are
deemed less likely to affect a member's or candidate's objectivity and
independence than gifts in other situations. Disclosure is required, however,
so that supervisors can monitor such situations to guard against employees
favoring a gift-giving client to the detriment of other fee-paying clients
(such as by allocating a greater proportion of IPO stock to the gift-giving
client's portfolio).
Best practices for monitoring include comparing the
transaction costs of the Knowlden account with the costs of other accounts
managed by Green and other similar accounts within Tisbury. The supervisor
could also compare the performance returns with the returns of other clients
with the same mandate. This comparison will assist in determining whether a
pattern of favoritism by Green is disadvantaging other Tisbury clients or the
possibility that this favoritism could affect her future behavior.
Example 5 (Research Independence and Compensation
Arrangements)
Javier Herrero recently left his job as a research analyst for
a large investment adviser. While looking for a new position, he was hired by
an investor-relations firm to write a research report on one of its clients, a
small educational software company. The investorrelations firm hopes to
generate investor interest in the technology company. The firm will pay Herrero
a flat fee plus a bonus if any new investors buy stock in the company as a
result of Herrero's report.
Comment: If Herrero accepts this payment arrangement, he will
be in violation of Standard I(B) because the compensation arrangement can
reasonably be expected to compromise his independence and objectivity. Herrero
will receive a bonus for attracting investors, which provides an incentive to
draft a positive report regardless of the facts and to ignore or play down any
negative information about the company. Herrero should accept only a flat fee
that is not tied to the conclusions or recommendations of the report.
Issuer-paid research that is objective and unbiased can be done under the right
circumstances as long as the analyst takes steps to maintain his or her
objectivity and includes in the report proper disclosures regarding potential
conflicts of interest.
Example 6 (Influencing Manager Selection Decisions)
|
Adrian Mandel, CFA, is a senior portfolio manager for ZZYY Capital Management
who oversees a team of investment professionals who manage labor union pension
funds. A few years ago, ZZYY sought to win a competitive asset manager search
to manage a significant allocation of the pension fund of the United Doughnut
and Pretzel Bakers Union (UDPBU). UDPBU's investment board is chaired by a
recognized key decision maker and longtime leader of the union, Ernesto Gomez.
To improve ZZYY's chances of winning the competition, Mandel made significant
monetary contributions to Gomez's union reelection campaign fund. Even after
ZZYY was hired as a primary manager of the pension, Mandel believed that his
firm's position was not secure. Mandel continued to contribute to Gomez's
reelection campaign chest as well as to entertain lavishly the union leader and
his family at top restaurants on a regular basis. All of Mandel's outlays were
routinely handled as marketing expenses reimbursed by ZZYY's expense accounts
and were disclosed to his senior management as being instrumental in
maintaining a strong close relationship with an important client.
Comment: Mandel not only offered but actually gave monetary
gifts, benefits, and other considerations that reasonably could be expected to
compromise Gomez's objectivity. Therefore, Mandel was in violation of Standard
I(B).
Example 7 (Influencing Manager
Selection Decisions)
Adrian Mandel, CFA, had heard
about the manager search competition for the UDPBU Pension Fund through a
broker/dealer contact. The contact told him that a well-known retired
professional golfer, Bobby "The Bear" Finlay, who had become a
licensed broker/ dealer serving as a pension consultant, was orchestrating the
UDPBU manager search. Finlay had gained celebrity status with several labor
union pension fund boards by entertaining their respective board members and
regaling them with colorful stories of fellow pro golfers' antics in clubhouses
around the world. Mandel decided to improve ZZYY's chances of being invited to
participate in the search competition by befriending Finlay to curry his favor.
Knowing Finlay's love of entertainment, Mandel wined and dined Finlay at
high-profile bistros where Finlay could glow in the fan recognition lavished on
him by all the other patrons. Mandel's endeavors paid off handsomely when
Finlay recommended to the UDPBU board that ZZYY be entered as one of three
finalist asset management firms in its search.
Comment: Mandel lavished gifts, benefits, and other
considerations in the form of expensive entertainment that could reasonably be
expected to influence the consultant to recommend the hiring of his firm.
Therefore, Mandel was in violation of Standard I(B).
Example 8 (Fund Manager Relationships)
Amie Scott is a performance analyst within her firm with
responsibilities for analyzing the performance of external managers. While
completing her quarterly analysis, Scott notices a change in one manager's
reported composite construction. The change concealed the bad performance of a
particularly large account by placing that account into a new residual
composite. This change allowed the manager to remain at the top of the list of
manager performance. Scott knows her firm has a large allocation to this
manager, and the fund's manager is a close personal friend of the CEO. She
needs to deliver her final report but is concerned with pointing out the
composite change.
 |
Comment: Scott would be in violation of Standard I(B) if she did not disclose
the change in her final report. The analysis of managers' performance should
not be influenced by personal relationships or the size of the allocation to
the outside managers. By not including the change, Scott would not be providing
an independent analysis of the performance metrics for her firm.
|
Example 9 (Intrafirm
Pressure) Jill Stein is head of performance
measurement for her firm. During the last quarter, many members of the
organization's research department were removed because of the poor quality
of their recommendations. The subpar research caused one larger account holder
to experience significant underperformance, which resulted in the client
withdrawing his money after the end of the quarter. The head of sales
requests that Stein remove this account from the firm's performance composite
because the performance decline can be attributed to the departed research
team and not the client's adviser. Comment:
Pressure from other internal departments can create situations that cause a
member or candidate to violate the Code and Standards. Stein must maintain
her independence and objectivity and refuse to exclude specific accounts from
the firm's performance composites to which they belong. As long as the client
invested under a strategy similar to that of the defined composite, it cannot
be excluded because of the poor stock selections that led to the
underperformance and asset withdrawal. |
Example 10 (Travel Expenses)
Steven Taylor, a mining analyst with Bronson
Brokers, is invited by Precision Metals to join a group of his peers in a tour
of mining facilities in several western U.S. states. The company arranges for
chartered group flights from site to site and for accommodations in Spartan
Motels, the only chain with accommodations near the mines, for three nights.
Taylor allows Precision Metals to pick up his tab, as do the other analysts,
with one
exception—John Adams, an employee of a large
trust company, who insists on following his company's policy and paying for his
hotel room himself.
Comment:
The policy of the company where Adams works complies closely with Standard I(B)
by avoiding even the appearance of a conflict of interest, but Taylor and the
other analysts were not necessarily violating Standard I(B). In general, when
allowing companies to pay for travel and/or accommodations in these
circumstances, members and candidates must use their judgment. They must be on
guard that such arrangements not impinge on a member's or candidate's
independence and objectivity. In this example, the trip was strictly for
business and Taylor was not accepting irrelevant or lavish hospitality. The
itinerary required chartered flights, for which analysts were not expected to
pay. The accommodations were modest. These arrangements are not unusual and did
not violate Standard I(B) as long as Taylor's independence and objectivity were
not compromised. In the final analysis, members and candidates should consider
both whether they can remain objective and whether their integrity might be
perceived by their clients to have been compromised.
Example 11
(Travel Expenses from External Manager)
Tom Wayne is the investment manager of the Franklin City Employees Pension
Plan. He recently completed a successful search for a firm to manage the
foreign equity allocation of the plan's diversified portfolio. He followed the
plan's standard procedure of seeking presentations from a number of qualified
firms and recommended that his board select Penguin Advisors because of its
experience, well-defined investment strategy, and performance record. The firm
claims compliance with the Global Investment Performance Standards (GIPS) and
has been verified. Following the selection of Penguin, a reporter from the
Franklin City Record calls to ask if there was any connection between this
action and the fact that Penguin was one of the sponsors of an "investment
fact-finding trip to Asia" that Wayne made earlier in the year. The trip
was one of several conducted by the Pension Investment Academy, which had
atTanged the itinerary of meetings with economic, government, and corporate
officials in major cities in several Asian countries. The Pension Investment
Academy obtains support for the cost of these trips from a number of investment
managers, including Penguin Advisors; the Academy then pays the travel expenses
of the various pension plan managers on the trip and provides all meals and
accommodations. The president of Penguin Advisors was also one of the travelers
on the trip.
Comment: Although Wayne can probably put to good use the
knowledge he gained from the trip in selecting portfolio managers and in other
areas of managing the pension plan, his recommendation of Penguin Advisors may
be tainted by the possible conflict incurred when he participated in a trip
partly paid for by Penguin Advisors and when he was in the daily company of the
president of Penguin Advisors. To avoid violating Standard I(B), Wayne's basic
expenses for travel and accommodations should have been paid by his employer or
the pension plan; contact with the president of Penguin Advisors should have
been limited to informational or educational events only; and the trip, the
organizer, and the sponsor should have been made a matter of public record.
Even if his actions were not in violation of Standard I(B), Wayne should have
been sensitive to the public perception of the trip when reported in the newspaper
and the extent to which the subjective elements of his decision might have been
affected by the familiarity that the daily contact of such a trip would
encourage. This advantage would probably not be shared by firms competing with
Penguin Advisors.
Example 12 (Recommendation
Objectivity)
Bob Thompson has been doing
research for the portfolio manager of the fixed-income department. His
assignment is to do sensitivity analysis on securitized subprime mortgages. He
has discussed with the manager possible scenarios to use to calculate expected
returns. A key assumption in such calculations is housing price appreciation
(HPA) because it drives "prepays" (prepayments of mortgages) and
losses. Thompson is concerned with the significant appreciation experienced
over the previous five years as a result of the increased availability of funds
from subprime mortgages. Thompson insists that the analysis should include a
scenario run with —10% for Year l, —5% for Year 2, and then (to project a
worst-case scenario) 0% for Years 3 through 5. The manager replies that these
assumptions are too dire because there has never been a time in their available
database when HPA was negative.
Thompson conducts his research to
better understand the risks inherent in these securities and evaluates these
securities in the worst-case scenario, an unlikely but possible environment.
Based on the results of the enhanced scenarios, Thompson does not recommend the
purchase of the securitization. Against the general market trends, the manager
follows Thompson's recommendation and does not invest. The following year, the
housing market collapses. In avoiding the subprime investments, the manager's
portfolio outperforms its peer group that year.
Comment: Thompson's actions in running the worst-case scenario against the
protests of the portfolio manager are in alignment with the principles of
Standard I(B). Thompson did not allow his research to be pressured by the
general trends of the market or the manager's desire to limit the research to
historical norms.
Example 13 (Research Independence
and Prior Coverage)
Jill Jorund is a securities
analyst following airline stocks and a rising star at her firm.
Her boss has been carrying a
"buy" recommendation on International Airlines and asks Jorund to
take over coverage of that airline. He tells Jorund that under no circumstances
should the prevailing buy recommendation be changed.
Comment: Jorund must be independent
and objective in her analysis of International Airlines. If she believes that
her boss's instructions have compromised her, she has two options: She can tell
her boss that she cannot cover the company under these constraints, or she can
take over coverage of the company, reach her own independent conclusions, and
if they conflict with her boss's opinion, share the conclusions with her boss
or other supervisors in the firm so that they can make appropriate
recommendations. Jorund must issue only recommendations that reflect her
independent and objective opinion.
Standard I(C)
Misrepresentation
The Standard
Members and candidates
must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions, or other professional activities.
Guidance
A misrepresentation is any
untrue statement or omission of a fact or any statement that is otherwise false
or misleading.
A member or candidate must
not knowingly omit or misrepresent information or give a false impression of a
firm, organization, or security in the member's or candidate's oral
representations, advertising (whether in the press or through brochures),
electronic communications, or written materials (whether publicly disseminated
or not).
In this context, "knowingly" means
that the member or candidate either knows or should have known that the
misrepresentation was being made or that omitted information could alter the
investment decision-making process.
Members and candidates who
use webpages should regularly monitor materials posted on these sites to ensure
that they contain current information. Members and candidates should also
ensure that all reasonable precautions have been taken to protect the site's
integrity and security and that the site does not misrepresent any information
and does provide full disclosure.
Members and candidates
should not guarantee clients any specific return on volatile investments. Most
investments contain some element of risk that makes their return inherently
unpredictable. For such investments, guaranteeing either a particular rate of
return or a guaranteed preservation of investment capital (e.g., "I can
guarantee that you will earn 8% on equities this year" or "I can
guarantee that you will not lose money on this investment") is misleading
to investors.
Note that Standard I(C) does not prohibit members and candidates from providing
clients with information on investment products that have guarantees built into
the structure of the products themselves or for which an institution has agreed
to cover any losses.
Impact on Investment
Practice
Members and candidates must
not misrepresent any aspect of their practice, including (but not limited to)
their qualifications or credentials, the qualifications or services provided by
their firm, their performance record and the record of their firm, and the
characteristics of an investment.
Members and candidates
should exercise care and diligence when incorporating third-party information.
Misrepresentations resulting from the use of the credit ratings, research,
testimonials, or marketing materials of outside parties become the
responsibility of the investment professional when it affects that professional
's business practices.
Members and candidates must
disclose their intended use of external managers and must not represent those
managers' investment practices as their own.
Performance Reporting
Members and candidates
should not misrepresent the success of their performance record by presenting
benchmarks that are not comparable to their strategies. The benchmark's results
should be reported on a basis comparable to that of the fund 's or client's
results.
Note that Standard I(C)
does not require that a benchmark always be provided in order to comply. Some
investment strategies may not lend themselves to displaying an appropriate
benchmark because of the complexity or diversity of the investments included.
Members and candidates
should discuss with clients on a continuous basis the appropriate benchmark to
be used for performance evaluations and related fee calculations.
Members and candidates
should take reasonable steps to provide accurate and reliable security pricing
information to clients on a consistent basis. Changing pricing providers should
not be based solely on the justification that the new provider reports a higher
current value of a security.
Social Media
When communicating through social
media channels, members and candidates should provide only the same information
they are allowed to distribute to clients and potential clients through other
traditional forms of communication. 
Along with understanding and following existing and newly
developing rules and regulations regarding the allowed use of social media,
members and candidates should also ensure that all communications in this
format adhere to the requirements of the Code and Standards.
The perceived anonymity
granted through these platforms may entice individuals to misrepresent their
qualifications or abilities or those of their employer. Actions undertaken
through social media that knowingly misrepresent investment recommendations or
professional activities are considered a violation of Standard I(C).
Omissions
Members and candidates should not knowingly omit inputs used in any models and
processes they use to scan for new investment opportunities, to develop
investment vehicles, and to produce investment recommendations and ratings as
resulting outcomes may provide misleading information. Further, members and
candidates should not present outcomes from their models as facts because they
only represent expected results.
Members and candidates
should encourage their firms to develop strict policies for composite development
to prevent cherry picking—situations in which selected accounts are presented
as representative of the firm's abilities. The omission of any accounts
appropriate for the defined composite may misrepresent to clients the success
of the manager's implementation of its strategy.
Plagiarism
Plagiarism refers to the
practice of copying, or using in substantially the same form, materials
prepared by others without acknowledging the source of the material or
identifying the author and publisher of the material. Plagiarism includes:
0 Taking a research
report or study performed by another firm or person, changing the names, and
releasing the material as one's own original analysis.
Using excerpts from articles or reports
prepared by others either verbatim or with only slight changes in wording
without acknowledgment.
Citing specific quotations
supposedly attributable to "leading analysts" and 
'investment experts"
without specific reference.
Presenting statistical estimates of forecasts
prepared by others with the source identified but without qualifying statements
or caveats that may have been used.
Using charts and graphs
without stating their sources.
Copying proprietary computerized spreadsheets
or algorithms without seeking the cooperation or authorization of their
creators.
In the case of distributing
third-party, outsourced research, members and candidates can use and distribute
these reports as long as they do not represent themselves as the author of the
report. They may add value to clients by sifting through research and
repackaging it for them, but should disclose that the research being presented
to clients comes from an outside source.
The standard also applies
to plagiarism in oral communications, such as through group meetings; visits
with associates, clients, and customers; use of audio/video media (which is
rapidly increasing); and telecommunications, such as through electronic data transfer
and the outright copying of electronic media. One of the most egregious
practices in violation of this standard is the preparation of research reports
based on multiple sources of information without acknowledging the sources.
Such information would include, for example, ideas, statistical compilations,
and forecasts combined to give the appearance of original work.
Work Completed for
Employer
Members and candidates may
use research conducted by other analysts within their firm. Any research
reports prepared by the analysts are the property of the firm and may be issued
by it even if the original analysts are no longer with the firm. 
Therefore, members and candidates are allowed to use the research
conducted by analysts who were previously employed at their firms. However,
they cannot reissue a previously released report solely under their own name.
Recommended Procedures for
Compliance
Factual presentations: Firms should provide guidance for employees who make
written or oral presentations to clients or potential clients by providing a
written list of the firm's available services and a description of the firm's
qualifications. Firms can also help prevent misrepresentation by specifically
designating which employees are authorized to speak on behalf of the firm.
Qualification summary: In
order to ensure accurate presentations to clients, the member or candidate
should prepare a summary of her own qualifications and experience, as well as a
list of the services she is capable of performing.
Verify outside
information: When providing information to clients from third parties, members
and candidates should ensure the accuracy of the marketing and distribution
materials that pertain to the third party's capabilities, services, and
products. This is because inaccurate information can damage their individual
and their firm's reputations as well as the integrity of the capital markets.
Maintain webpages: If
they publish a webpage, members and candidates should regularly monitor
materials posted to the site to ensure the site maintains current information.
Plagiarism policy: To
avoid plagiarism in preparing research reports or conclusions of analysis,
members and candidates should take the following steps:
Maintain copies: Keep copies of
all research reports, articles containing research ideas, material with new
statistical methodology, and other materials that were relied on in preparing
the research report.
Attribute quotations: Attribute to
their sources any direct quotations, including projections, tables, statistics,
model/product ideas, and new methodologies
prepared by persons other
than recognized financial and statistical reporting services or similar
sources.
Attribute summaries: Attribute to
their sources paraphrases or summaries of material prepared by others.
Application of the
Standard
Example 1 (Disclosure of
Issuer-Paid Research)
Anthony McGuire is an issuer-paid
analyst hired by publicly traded companies to electronically promote their
stocks. McGuire creates a website that promotes his research efforts as a
seemingly independent analyst. McGuire posts a profile and a strong buy recommendation
for each company on the website indicating that the stock is expected to
increase in value. He does not disclose the contractual relationships with the
companies he covers on his website, in the research reports he issues, or in
the statements he makes about the companies in Internet chat rooms.
Comment: McGuire has violated
Standard I(C) because the website is misleading to potential investors. Even if
the recommendations are valid and supported with thorough research, his
omissions regarding the true relationship between himself and the companies he
covers constitute a misrepresentation. McGuire has also violated Standard
VI(A)—Disclosure of Conflicts by not disclosing the existence of an arrangement
with the companies through which he receives compensation in exchange for his
services.
Example 2 (Correction of Unintentional Errors)
Hijan Yao is responsible for the creation and distribution of
the marketing materials for his firm, which claims compliance with the GIPS
standards. Yao creates and distributes a presentation of performance by the
firm's Asian equity composite that states the composite has ¥350 billion in
assets. In fact, the composite has only ¥35 billion in assets, and the higher
figure on the presentation is a result of a typographical error. Nevertheless,
the erroneous material is distributed to a number of clients before Yao catches
the mistake.
Comment: Once the error is
discovered, Yao must take steps to cease distribution of the incorrect material
and correct the error by informing those who have received the erroneous
information. Because Yao did not knowingly make the misrepresentation, however,
he did not violate Standard I(C). Because his firm claims compliance with the
GIPS standards, it must also comply with the GIPS Guidance Statement on Error
Correction in relation to the error.
Example 3 (Noncorrection of Known
Errors)
Syed Muhammad is the president of
an investment management firm. The promotional material for the firm, created
by the firm's marketing department, incorrectly claims that Muhammad has an
advanced degree in finance from a prestigious business school in addition to
the CFA designation. Although Muhammad attended the school for a short period
of time, he did not receive a degree. Over the years, Muhammad and others in
the firm have distributed this material to numerous prospective clients and consultants.
©
Comment: Even though Muhammad may
not have been directly responsible for the misrepresentation of his credentials
in the firm's promotional material, he used this material numerous times over
an extended period and should have known of the misrepresentation. Thus,
Muhammad has violated Standard I(C).
|
Tom Wayne is the investment manager of the Franklin City Employees Pension
Plan. He recently completed a successful search for a firm to manage the
foreign equity allocation of the plan's diversified portfolio. He followed the
plan's standard procedure of seeking presentations from a number of qualified
firms and recommended that his board select Penguin Advisors because of its
experience, well-defined investment strategy, and performance record. The firm
claims compliance with the Global Investment Performance Standards (GIPS) and
has been verified. Following the selection of Penguin, a reporter from the
Franklin City Record calls to ask if there was any connection between this
action and the fact that Penguin was one of the sponsors of an "investment
fact-finding trip to Asia" that Wayne made earlier in the year. The trip
was one of several conducted by the Pension Investment Academy, which had
atTanged the itinerary of meetings with economic, government, and corporate
officials in major cities in several Asian countries. The Pension Investment
Academy obtains support for the cost of these trips from a number of investment
managers, including Penguin Advisors; the Academy then pays the travel expenses
of the various pension plan managers on the trip and provides all meals and
accommodations. The president of Penguin Advisors was also one of the travelers
on the trip.
Comment: Although Wayne can probably put to good use the
knowledge he gained from the trip in selecting portfolio managers and in other
areas of managing the pension plan, his recommendation of Penguin Advisors may
be tainted by the possible conflict incurred when he participated in a trip
partly paid for by Penguin Advisors and when he was in the daily company of the
president of Penguin Advisors. To avoid violating Standard I(B), Wayne's basic
expenses for travel and accommodations should have been paid by his employer or
the pension plan; contact with the president of Penguin Advisors should have
been limited to informational or educational events only; and the trip, the
organizer, and the sponsor should have been made a matter of public record.
Even if his actions were not in violation of Standard I(B), Wayne should have
been sensitive to the public perception of the trip when reported in the newspaper
and the extent to which the subjective elements of his decision might have been
affected by the familiarity that the daily contact of such a trip would
encourage. This advantage would probably not be shared by firms competing with
Penguin Advisors.
Example 12 (Recommendation
Objectivity)
Bob Thompson has been doing
research for the portfolio manager of the fixed-income department. His
assignment is to do sensitivity analysis on securitized subprime mortgages. He
has discussed with the manager possible scenarios to use to calculate expected
returns. A key assumption in such calculations is housing price appreciation
(HPA) because it drives "prepays" (prepayments of mortgages) and
losses. Thompson is concerned with the significant appreciation experienced
over the previous five years as a result of the increased availability of funds
from subprime mortgages. Thompson insists that the analysis should include a
scenario run with —10% for Year l, —5% for Year 2, and then (to project a
worst-case scenario) 0% for Years 3 through 5. The manager replies that these
assumptions are too dire because there has never been a time in their available
database when HPA was negative.
Thompson conducts his research to
better understand the risks inherent in these securities and evaluates these
securities in the worst-case scenario, an unlikely but possible environment.
Based on the results of the enhanced scenarios, Thompson does not recommend the
purchase of the securitization. Against the general market trends, the manager
follows Thompson's recommendation and does not invest. The following year, the
housing market collapses. In avoiding the subprime investments, the manager's
portfolio outperforms its peer group that year.
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Comment: Thompson's actions in running the worst-case scenario against the
protests of the portfolio manager are in alignment with the principles of
Standard I(B). Thompson did not allow his research to be pressured by the
general trends of the market or the manager's desire to limit the research to
historical norms.
Example 13 (Research Independence
and Prior Coverage)
Jill Jorund is a securities
analyst following airline stocks and a rising star at her firm.
Her boss has been carrying a
"buy" recommendation on International Airlines and asks Jorund to
take over coverage of that airline. He tells Jorund that under no circumstances
should the prevailing buy recommendation be changed.
Comment: Jorund must be independent
and objective in her analysis of International Airlines. If she believes that
her boss's instructions have compromised her, she has two options: She can tell
her boss that she cannot cover the company under these constraints, or she can
take over coverage of the company, reach her own independent conclusions, and
if they conflict with her boss's opinion, share the conclusions with her boss
or other supervisors in the firm so that they can make appropriate
recommendations. Jorund must issue only recommendations that reflect her
independent and objective opinion.
Standard I(C)
Misrepresentation
The Standard
Members and candidates
must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions, or other professional activities.
Guidance
A misrepresentation is any
untrue statement or omission of a fact or any statement that is otherwise false
or misleading.
A member or candidate must
not knowingly omit or misrepresent information or give a false impression of a
firm, organization, or security in the member's or candidate's oral
representations, advertising (whether in the press or through brochures),
electronic communications, or written materials (whether publicly disseminated
or not).
In this context, "knowingly" means
that the member or candidate either knows or should have known that the
misrepresentation was being made or that omitted information could alter the
investment decision-making process.
Members and candidates who
use webpages should regularly monitor materials posted on these sites to ensure
that they contain current information. Members and candidates should also
ensure that all reasonable precautions have been taken to protect the site's
integrity and security and that the site does not misrepresent any information
and does provide full disclosure.
Members and candidates
should not guarantee clients any specific return on volatile investments. Most
investments contain some element of risk that makes their return inherently
unpredictable. For such investments, guaranteeing either a particular rate of
return or a guaranteed preservation of investment capital (e.g., "I can
guarantee that you will earn 8% on equities this year" or "I can
guarantee that you will not lose money on this investment") is misleading
to investors.
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Note that Standard I(C) does not prohibit members and candidates from providing
clients with information on investment products that have guarantees built into
the structure of the products themselves or for which an institution has agreed
to cover any losses.
Impact on Investment
Practice
Members and candidates must
not misrepresent any aspect of their practice, including (but not limited to)
their qualifications or credentials, the qualifications or services provided by
their firm, their performance record and the record of their firm, and the
characteristics of an investment.
Members and candidates
should exercise care and diligence when incorporating third-party information.
Misrepresentations resulting from the use of the credit ratings, research,
testimonials, or marketing materials of outside parties become the
responsibility of the investment professional when it affects that professional
's business practices.
Members and candidates must
disclose their intended use of external managers and must not represent those
managers' investment practices as their own.
Performance Reporting
Members and candidates
should not misrepresent the success of their performance record by presenting
benchmarks that are not comparable to their strategies. The benchmark's results
should be reported on a basis comparable to that of the fund 's or client's
results.
Note that Standard I(C)
does not require that a benchmark always be provided in order to comply. Some
investment strategies may not lend themselves to displaying an appropriate
benchmark because of the complexity or diversity of the investments included.
Members and candidates
should discuss with clients on a continuous basis the appropriate benchmark to
be used for performance evaluations and related fee calculations.
Members and candidates
should take reasonable steps to provide accurate and reliable security pricing
information to clients on a consistent basis. Changing pricing providers should
not be based solely on the justification that the new provider reports a higher
current value of a security.
Social Media
When communicating through social
media channels, members and candidates should provide only the same information
they are allowed to distribute to clients and potential clients through other
traditional forms of communication. Along with understanding and following existing and newly
developing rules and regulations regarding the allowed use of social media,
members and candidates should also ensure that all communications in this
format adhere to the requirements of the Code and Standards.
The perceived anonymity
granted through these platforms may entice individuals to misrepresent their
qualifications or abilities or those of their employer. Actions undertaken
through social media that knowingly misrepresent investment recommendations or
professional activities are considered a violation of Standard I(C).
Omissions
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Members and candidates should not knowingly omit inputs used in any models and
processes they use to scan for new investment opportunities, to develop
investment vehicles, and to produce investment recommendations and ratings as
resulting outcomes may provide misleading information. Further, members and
candidates should not present outcomes from their models as facts because they
only represent expected results.
Members and candidates
should encourage their firms to develop strict policies for composite development
to prevent cherry picking—situations in which selected accounts are presented
as representative of the firm's abilities. The omission of any accounts
appropriate for the defined composite may misrepresent to clients the success
of the manager's implementation of its strategy.
Plagiarism
Plagiarism refers to the
practice of copying, or using in substantially the same form, materials
prepared by others without acknowledging the source of the material or
identifying the author and publisher of the material. Plagiarism includes:
0 Taking a research
report or study performed by another firm or person, changing the names, and
releasing the material as one's own original analysis.
Using excerpts from articles or reports
prepared by others either verbatim or with only slight changes in wording
without acknowledgment.
Citing specific quotations
supposedly attributable to "leading analysts" and 'investment experts"
without specific reference.
Presenting statistical estimates of forecasts
prepared by others with the source identified but without qualifying statements
or caveats that may have been used.
Using charts and graphs
without stating their sources.
Copying proprietary computerized spreadsheets
or algorithms without seeking the cooperation or authorization of their
creators.
In the case of distributing
third-party, outsourced research, members and candidates can use and distribute
these reports as long as they do not represent themselves as the author of the
report. They may add value to clients by sifting through research and
repackaging it for them, but should disclose that the research being presented
to clients comes from an outside source.
The standard also applies
to plagiarism in oral communications, such as through group meetings; visits
with associates, clients, and customers; use of audio/video media (which is
rapidly increasing); and telecommunications, such as through electronic data transfer
and the outright copying of electronic media. One of the most egregious
practices in violation of this standard is the preparation of research reports
based on multiple sources of information without acknowledging the sources.
Such information would include, for example, ideas, statistical compilations,
and forecasts combined to give the appearance of original work.
Work Completed for
Employer
Members and candidates may
use research conducted by other analysts within their firm. Any research
reports prepared by the analysts are the property of the firm and may be issued
by it even if the original analysts are no longer with the firm. Therefore, members and candidates are allowed to use the research
conducted by analysts who were previously employed at their firms. However,
they cannot reissue a previously released report solely under their own name.
Recommended Procedures for
Compliance
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Factual presentations: Firms should provide guidance for employees who make
written or oral presentations to clients or potential clients by providing a
written list of the firm's available services and a description of the firm's
qualifications. Firms can also help prevent misrepresentation by specifically
designating which employees are authorized to speak on behalf of the firm.
Qualification summary: In
order to ensure accurate presentations to clients, the member or candidate
should prepare a summary of her own qualifications and experience, as well as a
list of the services she is capable of performing.
Verify outside
information: When providing information to clients from third parties, members
and candidates should ensure the accuracy of the marketing and distribution
materials that pertain to the third party's capabilities, services, and
products. This is because inaccurate information can damage their individual
and their firm's reputations as well as the integrity of the capital markets.
Maintain webpages: If
they publish a webpage, members and candidates should regularly monitor
materials posted to the site to ensure the site maintains current information.
Plagiarism policy: To
avoid plagiarism in preparing research reports or conclusions of analysis,
members and candidates should take the following steps:
Maintain copies: Keep copies of
all research reports, articles containing research ideas, material with new
statistical methodology, and other materials that were relied on in preparing
the research report.
Attribute quotations: Attribute to
their sources any direct quotations, including projections, tables, statistics,
model/product ideas, and new methodologies
prepared by persons other
than recognized financial and statistical reporting services or similar
sources.
Attribute summaries: Attribute to
their sources paraphrases or summaries of material prepared by others.
Application of the
Standard
Example 1 (Disclosure of
Issuer-Paid Research)
Anthony McGuire is an issuer-paid
analyst hired by publicly traded companies to electronically promote their
stocks. McGuire creates a website that promotes his research efforts as a
seemingly independent analyst. McGuire posts a profile and a strong buy recommendation
for each company on the website indicating that the stock is expected to
increase in value. He does not disclose the contractual relationships with the
companies he covers on his website, in the research reports he issues, or in
the statements he makes about the companies in Internet chat rooms.
Comment: McGuire has violated
Standard I(C) because the website is misleading to potential investors. Even if
the recommendations are valid and supported with thorough research, his
omissions regarding the true relationship between himself and the companies he
covers constitute a misrepresentation. McGuire has also violated Standard
VI(A)—Disclosure of Conflicts by not disclosing the existence of an arrangement
with the companies through which he receives compensation in exchange for his
services.
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Example 2 (Correction of Unintentional Errors)
Hijan Yao is responsible for the creation and distribution of
the marketing materials for his firm, which claims compliance with the GIPS
standards. Yao creates and distributes a presentation of performance by the
firm's Asian equity composite that states the composite has ¥350 billion in
assets. In fact, the composite has only ¥35 billion in assets, and the higher
figure on the presentation is a result of a typographical error. Nevertheless,
the erroneous material is distributed to a number of clients before Yao catches
the mistake.
Comment: Once the error is
discovered, Yao must take steps to cease distribution of the incorrect material
and correct the error by informing those who have received the erroneous
information. Because Yao did not knowingly make the misrepresentation, however,
he did not violate Standard I(C). Because his firm claims compliance with the
GIPS standards, it must also comply with the GIPS Guidance Statement on Error
Correction in relation to the error.
Example 3 (Noncorrection of Known
Errors)
Syed Muhammad is the president of
an investment management firm. The promotional material for the firm, created
by the firm's marketing department, incorrectly claims that Muhammad has an
advanced degree in finance from a prestigious business school in addition to
the CFA designation. Although Muhammad attended the school for a short period
of time, he did not receive a degree. Over the years, Muhammad and others in
the firm have distributed this material to numerous prospective clients and consultants.
©
Comment: Even though Muhammad may
not have been directly responsible for the misrepresentation of his credentials
in the firm's promotional material, he used this material numerous times over
an extended period and should have known of the misrepresentation. Thus,
Muhammad has violated Standard I(C).
Example 4 (Misrepresentation of Information)
When Ricki Marks sells mortgage-backed
derivatives called "interest-only strips" (IOS) to public pension
plan clients, she describes them as "guaranteed by the U.S. government."
Purchasers of the IOS are entitled to only the interest stream generated by the
mortgages, however, not the notional principal itself. One particular
municipality's investment policies and local law require that securities
purchased by its public pension plans be guaranteed by the U.S. government.
Although the underlying mortgages are guaranteed, neither the investor's
investment nor the interest stream on the IOS is guaranteed. When interest
rates decline, causing an increase in prepayment of mortgages, interest
payments to the IOS' investors decline, and these investors lose a portion of
their investment.
Comment:
Marks violated Standard I(C) by misrepresenting the terms and character of the
investment.
Example 5 (Potential Information Misrepresentation)
Khalouck Abdrabbo manages the investments of several high-net-worth individuals
in the United States who are approaching retirement. Abdrabbo advises these
individuals that a portion of their investments should be moved from equity to
bank-sponsored certificates of deposit and money market accounts so that the
principal will be "guaranteed" up to a certain amount. The interest
is not guaranteed.
Comment: Although there is risk that the institution offering
the certificates of deposit and money market accounts could go bankrupt, in the
United States, these accounts are insured by the U.S. government through the
Federal Deposit Insurance Corporation. Therefore, using the term
"guaranteed" in this context is not inappropriate as long as the
amount is within the government-insured limit. Abdrabbo should explain these
facts to the clients.
Example 6 (Plagiarism)
Steve Swanson is a senior analyst in the
investment research department of Ballard and Company. Apex Corporation has
asked Ballard to assist in acquiring the majority ownership of stock in the
Campbell Company, a financial consulting firm, and to prepare a report
recommending that stockholders of Campbell agree to the acquisition. Another
investment firm, Davis and Company, had already prepared a report for Apex
analyzing both Apex and Campbell and recommending an exchange ratio. Apex has
given the Davis report to Ballard officers, who have passed it on to Swanson.
Swanson reviews the Davis report and other available material on Apex and
Campbell. From his analysis, he concludes that the common stocks of Campbell
and Apex represent good value at
their current
prices; he believes, however, that the Davis report does not consider all the
factors a Campbell stockholder would need to know to make a decision. Swanson
reports his conclusions to the partner in charge, who tells him to "use
the Davis report, change a few words, sign your name, and get it out."
Comment: If Swanson does as
requested, he will violate Standard I(C). He could refer to those portions of
the Davis report that he agrees with if he identifies Davis as the source; he
could then add his own analysis and conclusions to the report before signing
and distributing it.
Example 7 (Plagiarism)
Claude Browning, a quantitative analyst for Double Alpha,
Inc., returns from a seminar in great excitement. At that seminar, Jack
Jorrely, a well-known quantitative analyst at a national brokerage firm,
discussed one of his new models in great detail, and Browning is intrigued by
the new concepts. He proceeds to test the model, making some minor mechanical
changes but retaining the concepts, until he produces some very positive
results. Browning quickly announces to his supervisors at Double Alpha that he
has discovered a new model and that clients and prospective clients should be
informed of this positive finding as ongoing proof of Double Alpha's continuing
innovation and ability to add value.
Comment: Although Browning tested Jorrely's model on his own and even slightly
modified it, he must still acknowledge the original source of the idea.
Browning can certainly take credit for the final, practical results; he can
also support his conclusions with his own test. The credit for the innovative
thinking, however, must be awarded to Jorrely.
Example 8 (Plagiarism)
Fernando Zubia would like to include in his firm's marketing
materials some "plainlanguage" descriptions of various concepts, such
as the price-to-earnings (P/E) multiple and why standard deviation is used as a
measure of risk. The descriptions come from other sources, but Zubia wishes to
use them without reference to the original authors. Would this use of material
be a violation of Standard I(C)?
Comment: Copying verbatim any material without acknowledgment,
including plainlanguage descriptions of the P/E multiple and standard
deviation, violates Standard I(C). Even though these concepts are general, best
practice would be for Zubia to describe them in his own words or cite the
sources from which the descriptions are quoted. Members and candidates would be
violating Standard I(C) if they either were responsible for creating marketing
materials without attribution or knowingly use plagiarized materials.
©
Example 9 (Plagiarism)
Through a mainstream media outlet, Erika Schneider learns
about a study that she would like to cite in her research. Should she cite both
the mainstream intermediary source as well as the author of the study itself
when using that information?
Comment: In all instances, a member or candidate must cite the actual source of
the information. Best practice for Schneider would be to obtain the information
directly from the author and review it before citing it in a report. In that
case, Schneider would not need to report how she found out about the
information. For example, suppose Schneider read in the Financial Times about a
study issued by CFA Institute; best practice for Schneider would be to obtain a
copy of the study from CFA Institute, review it, and then cite it in her
report. If she does not use any interpretation of the report from the Financial
Times and the newspaper does not add value to the report itself, the newspaper
is merely a conduit of the original information and does not need to be cited.
If she does not obtain the report and review the information, Schneider runs
the risk of relying on secondhand information that may misstate facts. If, for
example, the Financial Times erroneously reported some information from the
original CFA Institute study and Schneider copied that erroneous information
without acknowledging CFA Institute, she could be the object of complaints.
Best practice would be either to obtain the complete study from its original
author and cite only that author or to use the information provided by the
intermediary and cite both sources.
When Ricki Marks sells mortgage-backed
derivatives called "interest-only strips" (IOS) to public pension
plan clients, she describes them as "guaranteed by the U.S. government."
Purchasers of the IOS are entitled to only the interest stream generated by the
mortgages, however, not the notional principal itself. One particular
municipality's investment policies and local law require that securities
purchased by its public pension plans be guaranteed by the U.S. government.
Although the underlying mortgages are guaranteed, neither the investor's
investment nor the interest stream on the IOS is guaranteed. When interest
rates decline, causing an increase in prepayment of mortgages, interest
payments to the IOS' investors decline, and these investors lose a portion of
their investment.
Comment:
Marks violated Standard I(C) by misrepresenting the terms and character of the
investment.
Example 5 (Potential Information Misrepresentation)
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Khalouck Abdrabbo manages the investments of several high-net-worth individuals
in the United States who are approaching retirement. Abdrabbo advises these
individuals that a portion of their investments should be moved from equity to
bank-sponsored certificates of deposit and money market accounts so that the
principal will be "guaranteed" up to a certain amount. The interest
is not guaranteed.
Comment: Although there is risk that the institution offering
the certificates of deposit and money market accounts could go bankrupt, in the
United States, these accounts are insured by the U.S. government through the
Federal Deposit Insurance Corporation. Therefore, using the term
"guaranteed" in this context is not inappropriate as long as the
amount is within the government-insured limit. Abdrabbo should explain these
facts to the clients.
Example 6 (Plagiarism)
Steve Swanson is a senior analyst in the
investment research department of Ballard and Company. Apex Corporation has
asked Ballard to assist in acquiring the majority ownership of stock in the
Campbell Company, a financial consulting firm, and to prepare a report
recommending that stockholders of Campbell agree to the acquisition. Another
investment firm, Davis and Company, had already prepared a report for Apex
analyzing both Apex and Campbell and recommending an exchange ratio. Apex has
given the Davis report to Ballard officers, who have passed it on to Swanson.
Swanson reviews the Davis report and other available material on Apex and
Campbell. From his analysis, he concludes that the common stocks of Campbell
and Apex represent good value at
their current
prices; he believes, however, that the Davis report does not consider all the
factors a Campbell stockholder would need to know to make a decision. Swanson
reports his conclusions to the partner in charge, who tells him to "use
the Davis report, change a few words, sign your name, and get it out."
Comment: If Swanson does as
requested, he will violate Standard I(C). He could refer to those portions of
the Davis report that he agrees with if he identifies Davis as the source; he
could then add his own analysis and conclusions to the report before signing
and distributing it.
Example 7 (Plagiarism)
Claude Browning, a quantitative analyst for Double Alpha,
Inc., returns from a seminar in great excitement. At that seminar, Jack
Jorrely, a well-known quantitative analyst at a national brokerage firm,
discussed one of his new models in great detail, and Browning is intrigued by
the new concepts. He proceeds to test the model, making some minor mechanical
changes but retaining the concepts, until he produces some very positive
results. Browning quickly announces to his supervisors at Double Alpha that he
has discovered a new model and that clients and prospective clients should be
informed of this positive finding as ongoing proof of Double Alpha's continuing
innovation and ability to add value.
|
Comment: Although Browning tested Jorrely's model on his own and even slightly
modified it, he must still acknowledge the original source of the idea.
Browning can certainly take credit for the final, practical results; he can
also support his conclusions with his own test. The credit for the innovative
thinking, however, must be awarded to Jorrely.
Example 8 (Plagiarism)
Fernando Zubia would like to include in his firm's marketing
materials some "plainlanguage" descriptions of various concepts, such
as the price-to-earnings (P/E) multiple and why standard deviation is used as a
measure of risk. The descriptions come from other sources, but Zubia wishes to
use them without reference to the original authors. Would this use of material
be a violation of Standard I(C)?
Comment: Copying verbatim any material without acknowledgment,
including plainlanguage descriptions of the P/E multiple and standard
deviation, violates Standard I(C). Even though these concepts are general, best
practice would be for Zubia to describe them in his own words or cite the
sources from which the descriptions are quoted. Members and candidates would be
violating Standard I(C) if they either were responsible for creating marketing
materials without attribution or knowingly use plagiarized materials.
©
Example 9 (Plagiarism)
Through a mainstream media outlet, Erika Schneider learns
about a study that she would like to cite in her research. Should she cite both
the mainstream intermediary source as well as the author of the study itself
when using that information?
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Comment: In all instances, a member or candidate must cite the actual source of
the information. Best practice for Schneider would be to obtain the information
directly from the author and review it before citing it in a report. In that
case, Schneider would not need to report how she found out about the
information. For example, suppose Schneider read in the Financial Times about a
study issued by CFA Institute; best practice for Schneider would be to obtain a
copy of the study from CFA Institute, review it, and then cite it in her
report. If she does not use any interpretation of the report from the Financial
Times and the newspaper does not add value to the report itself, the newspaper
is merely a conduit of the original information and does not need to be cited.
If she does not obtain the report and review the information, Schneider runs
the risk of relying on secondhand information that may misstate facts. If, for
example, the Financial Times erroneously reported some information from the
original CFA Institute study and Schneider copied that erroneous information
without acknowledging CFA Institute, she could be the object of complaints.
Best practice would be either to obtain the complete study from its original
author and cite only that author or to use the information provided by the
intermediary and cite both sources.
Example
10 (Misrepresentation of Information)
Tom Stafford is part of a team
within Appleton Investment Management responsible for managing a pool of assets
for Open Air Bank, which distributes structured securities to offshore clients.
He becomes aware that Open Air is promoting the structured securities as a much
less risky investment than the investment management policy followed by him and
the team to manage the original pool of assets. Also, Open Air has procured an
independent rating for the pool that significantly overstates the quality of
the investments. Stafford communicates his concerns to his supervisor, who
responds that Open Air owns the product and is responsible for all marketing
and distribution. Stafford's supervisor goes on to say that the product is
outside of the U S. regulatory regime that Appleton follows and that all risks
of the product are disclosed at the bottom of page 184 of the prospectus.
Comment: As a member of the
investment team, Stafford is qualified to recognize the degree of accuracy of
the materials that characterize the portfolio, and he is correct to be worried
about Appleton's responsibility for a misrepresentation of the risks. Thus, he
should continue to pursue the issue of Open Air's inaccurate promotion of the
portfolio according to the firm's policies and procedures.
The Code and Standards stress
protecting the reputation of the firm and the sustainability and integrity of
the capital markets. Misrepresenting the quality and risks associated with the
investment pool may lead to negative consequences for others well beyond the
direct investors.
Example 11 (Misrepresenting
Composite Construction)
Robert Palmer is head of
performance for a fund manager. When asked to provide performance numbers to
fund rating agencies, he avoids mentioning that the fund manager is quite
liberal in composite construction. The reason accounts are included/ excluded is
not fully explained. The performance values reported to the rating agencies for
the composites, although accurate for the accounts shown each period, may not
present a true representation of the fund manager's ability.
Comment: "Cherry
picking" accounts to include in either published reports or information
provided to rating agencies conflicts with Standard I(C). Moving accounts into
or out of a composite to influence the overall performance results materially
misrepresents the reported values over time. Palmer should work with his firm
to strengthen its reporting practices concerning composite construction to
avoid misrepresenting the firm's track record or the quality of the information
being provided.
Example 12 (Overemphasis of Firm Results)
Bob Anderson is chief compliance officer for Optima Asset Management Company, a
firm currently offering eight funds to clients. Seven of the eight had 10-year
returns below the median for their respective sectors. Anderson approves a
recent advertisement, which includes this statement: "Optima Asset
Management is achieving excellent returns for its investors. The Optima
Emerging Markets Equity fund, for example, has 10-year returns that exceed the
sector median by more than 10%."
Comment: From the information provided it is difficult to
determine whether a violation has occurred as long as the sector outperformance
is correct. Anderson may be attempting to mislead potential clients by citing
the performance of the sole fund that achieved such results. Past performance
is often used to demonstrate a firm's skill and abilities in comparison to
funds in the same sectors.
However, if all
the funds outperformed their respective benchmarks, then Anderson 's assertion
that the company "is achieving excellent returns" may be factual.
Funds may exhibit positive returns for investors, exceed benchmarks, and yet
have returns below the median in their sectors.
Members and candidates need to ensure that their marketing
efforts do not include statements that misrepresent their skills and abilities
to remain compliant with Standard I(C). Unless the returns of a single fund
reflect the performance of a firm as a whole, the use of a singular fund for
performance comparisons should be avoided.
Standard I(D) Misconduct
The Standard
Members and candidates
must not engage in any professional conduct involving dishonesty, fraud, or
deceit, or commit any act that reflects adversely on their professional
reputation, integrity, or competence.
Guidance
While Standard I(A) addresses the
obligation of members and candidates to comply with applicable law that governs
their professional activities, Standard I(D) addresses all conduct that
reflects poorly on the professional integrity, good reputation, or competence
of members and candidates. Any act that involves lying, cheating, stealing, or
other dishonest conduct is a violation of this standard if the offense reflects
adversely on a member's or candidate's professional activities.
Conduct that damages
trustworthiness or competence may include behavior that, although not illegal,
nevertheless negatively affects a member's or candidate's ability to perform
his or her responsibilities. For example:
Abusing alcohol during business hours might
constitute a violation of this standard because it could have a detrimental
effect on the member's or candidate's ability to fulfill his or her
professional responsibilities.
Personal bankruptcy may not
reflect on the integrity or trustworthiness of the person declaring bankruptcy,
but if the circumstances of the bankruptcy involve fraudulent or deceitful
business conduct, the bankruptcy may be a violation of this standard.
In some cases, the absence of appropriate conduct or the lack of sufficient
effort may be a violation of Standard I(D). The integrity of the investment
profession is built on trust. A member or candidate—whether an investment
banker, rating or research analyst, or portfolio manager—is expected to conduct
the necessary due diligence to properly understand the nature and risks of an
investment before making an investment recommendation. By not taking these
steps and, instead, relying on someone else in the process to perform them,
members or candidates may violate the trust their clients have placed in them.
This loss of trust may have a significant impact on the reputation of the
member or candidate and the operations of the financial market as a whole.
Note that Standard I(D) or any
other standard should not be used to settle personal, political, or other
disputes unrelated to professional ethics.
Recommended Procedures for
Compliance
Members and candidates
should encourage their firms to adopt the following policies and procedures to
support the principles of Standard I(D):
Code of ethics: Develop and/or
adopt a code of ethics to which every employee must subscribe, and make clear
that any personal behavior that reflects poorly on the individual involved, the
institution as a whole, or the investment industry will not be tolerated.
List of violations: Disseminate to
all employees a list of potential violations and associated disciplinary
sanctions, up to and including dismissal from the firm. 
Employee references: Check references of
potential employees to ensure that they are of good character and not
ineligible to work in the investment industry because of past infractions of
the law.
Application of the
Standard
Example
1 (Professionalism and Competence)
Simon
Sasserman is a trust investment officer at a bank in a small affluent town. He
enjoys lunching every day with friends at the country club, where his clients
have observed him having numerous drinks. Back at work after lunch, he clearly
is intoxicated while making investment
decisions. His colleagues make a point of handling any business with Sasserman
in the morning because they distrust his judgment after lunch.
Comment: Sasserman's excessive drinking at
lunch and subsequent intoxication at work constitute a violation of Standard
I(D) because this conduct has raised questions about his professionalism and
competence. His behavior reflects poorly on him, his employer, and the
investment industry.
Example
2 (Fraud and Deceit)
Howard
Hoffman, a security analyst at ATZ Brothers, Inc., a large brokerage house,
submits reimbursement forms over a two-year period to ATZ's self-funded health
insurance program for more than two dozen bills, most of which have been
altered to increase the amount due. An investigation by the firm's director of
employee benefits uncovers the inappropriate conduct. ATZ subsequently
terminates Hoffman's employment and notifies CFA Institute.
Comment:
Hoffman violated Standard I(D) because he engaged in intentional conduct
involving fraud and deceit in the workplace that adversely reflected on his
integrity.
Example 3 (Personal Actions and Integrity)
Carmen Garcia manages a mutual fund dedicated to socially
responsible investing. She is also an environmental activist. As the result of
her participation in nonviolent protests, Garcia has been arrested on numerous
occasions for trespassing on the property of a large petrochemical plant that
is accused of damaging the environment.
Comment: Generally, Standard I(D) is not meant to cover legal
transgressions resulting from acts of civil disobedience in support of personal
beliefs because such conduct does not reflect poorly on the member's or
candidate's professional reputation, integrity, or competence.
Example 4 (Professional
Misconduct)
Meredith Rasmussen works on a buy-side trading desk of
an investment management firm and concentrates on in-house trades for a hedge
fund subsidiary managed by a team at the investment management firm. The hedge
fund has been very successful and is marketed globally by the firm. From her
experience as the trader for much of the activity of the fund, Rasmussen has
become quite knowledgeable about the hedge fund's strategy, tactics, and
performance. When a distinct break in the market occurs and many of the
securities involved in the hedge fund's strategy decline markedly in value,
Rasmussen observes that the reported performance of the hedge fund does not
reflect this decline. In her experience, the lack of effect is a very unlikely
occurrence. She approaches the head of trading about her concern and is told
that she should not ask any questions and that the fund is big and successful
and is not her concern. She is fairly sure something is not right, so she
contacts the compliance officer, who also tells her to stay away from the issue
of the hedge fund's reporting.
Comment: Misconduct covers any activity that violates the Code
and Standards. In this case, Rasmussen suspects supervisors in the firm are
knowingly misreporting performance and violating the Code and Standards. While
she is under no obligation to report the misconduct unless required by
applicable law, she must dissociate herself with the activity, and, due to the
compliance officer's response to her report, she should consider reporting the
activity to regulatory authorities. She should thoroughly document her attempts
to dissociate herself and report the activity to supervisors and the compliance
officer along with any further action she pursues. Documenting the activity may
provide shelter should she be blamed in some way for a role in the misconduct.
See also Standard IV(A) for guidance on whistleblowing.
LESSON 2: STANDARD 11:
INTEGRITY OF CAPITAL MARKET
Material Nonpublic
Information
B. Market Manipulation
Standard Il(A) Material
Nonpublic Information
The Standard
Members and candidates
who possess material nonpublic information that could affect the value of an
investment must not act or cause others to act on the information.
Guidance
•
Standard Il(A) is related to information that is material and is nonpublic. Such
information must not be used for direct buying and selling of individual
securities or bonds, nor to influence investment actions related to
derivatives, mutual funds, or other alternative investments.
Material Information
Information is
"material" if its disclosure would likely have an impact on the price
of a security, or if reasonable investors would want to know the information
before making an investment decision. Material information may include, but is
not limited to, information relating to the following:
•
Earnings.
•
Mergers, acquisitions,
tender offers, or joint ventures.
•
Changes in assets.
•
Innovative products,
processes, or discoveries.
•
New licenses, patents,
registered trademarks, or regulatory approval/rejection of a product.
•
Developments regarding
customers or suppliers (e.g., the acquisition or loss of a contract).
•
Changes in management.
•
Change in auditor
notification or the fact that the issuer may no longer rely on an auditor's
report or qualified opinion.
•
Events regarding the
issuer's securities (e.g., defaults on senior securities, calls of securities
for redemption, repurchase plans, stock splits, changes in dividends, changes
to the rights of security holders, public or private sales of additional securities,
and changes in credit ratings).
•
Bankruptcies.
•
Significant legal disputes.
•
Government reports of
economic trends (employment, housing starts, currency information, etc.).
•
Orders for large trades
before they are executed.
•
New or changing equity or debt
ratings issued by a third party (e.g., sell-side recommendations and credit
ratings).
•
To determine if information
is material, members and candidates should consider the source of information
and the information's likely effect on the relevant stock price. 
The less reliable a source, the less likely
the information provided would be considered material.
•
The more ambiguous the
effect on price, the less material the information becomes.
If it is unclear whether the information will
affect the price of a security and to what extent, information may not be
considered material.
Nonpublic Information
•
Information is
"nonpublic" until it has been disseminated or is available to the
marketplace in general (as opposed to a select group of investors).
"Disseminated" can be defined as ''made known."
For example, a company report of profits that
is posted on the Internet and distributed widely through a press release or
accompanied by a filing has been effectively disseminated to the marketplace.
•
Members and candidates must be particularly aware of information that is
selectively disclosed by corporations to a small group of investors, analysts,
or other market participants. Information that is made available to analysts
remains nonpublic until it is made available to investors in general.
•
Analysts should also be
alert to the possibility that they are selectively receiving material nonpublic
information when a company provides them with guidance or interpretation of
such publicly available information as financial statements or regulatory
filings.
•
A member or candidate may
use insider information provided legitimately by the source company for the
specific purpose of conducting due diligence according to the business
agreement between the parties for such activities as mergers, loan
underwriting, credit ratings, and offering engagements. However, the use of
insider information provided by the source company for other purposes,
especially to trade or entice others to trade the securities of the firm,
conflicts with this standard.
Mosaic Theory
•
A financial analyst may use
significant conclusions derived from the analysis of public information and
nonmaterial nonpublic information as the basis for investment recommendations
and decisions. Under the "mosaic theory," financial analysts are free
to act on this collection, or mosaic, of information without risking violation,
even when the conclusion they reach would have been material inside information
had the company communicated the same.
•
Investment professionals
should note, however, that although analysts are free to use mosaic information
in their research reports, they should save and document all their research
[see Standard V(C)].
Social Media
•
Members and candidates
participating in online discussion forums/groups with membership limitations
should verify that material information obtained from these sources can also be
accessed from a source that would be considered available to the public (e.g.,
company filings, webpages, and press releases).
•
Members and candidates may
use social media platforms to communicate with clients or investors without
conflicting with this standard.
•
Members and candidates, as
required by Standard I(A), should also complete all appropriate regulatory
filings related to information distributed through social media platforms.
Using Industry Experts
•
The increased demand for
insights for understanding the complexities of some industries has led to an
expansion of engagement with outside experts. Members and candidates may
provide compensation to individuals for their insights without violating this
standard.
•
However, members and
candidates are ultimately responsible for ensuring that they are not requesting
or acting on confidential information received from external experts, which is
in violation of security regulations and laws or duties to others.
Investment Research Reports
•
It might often be the case that reports prepared by well-known analysts may
have an effect on the market and thus may be considered material information.
Theoretically, such a report might have to be made public before it was
distributed to clients. However, since the analyst is not a company insider,
and presumably prepared the report based on publicly available information, the
report does not need to be made public just because its conclusions are
material. Investors who want to use that report must become clients of the
analyst.
Recommended Procedures for
Compliance
Achieve public
dissemination: If a member or candidate determines that some nonpublic
information is material, she should encourage the issuer to make the
information public. If public dissemination is not possible, she must
communicate the information only to the designated supervisory and compliance
personnel in her firm and must not take investment action on the basis of the
information.
Adopt compliance
procedures: Members and candidates should encourage their firms to adopt
compliance procedures to prevent the misuse of material nonpublic information.
Particularly important is improving compliance in areas such as review of
employee and proprietary trading, documentation of firm procedures, and the
supervision of interdepartmental communications in multiservice firms.
Adopt disclosure
procedures: Members and candidates should encourage their firms to develop and
follow disclosure policies designed to ensure that information is disseminated
in the marketplace in an equitable manner. An issuing company should not discriminate
among analysts in the provision of information or blackball particular analysts
who have given negative reports on the company in the past.
Issue press releases:
Companies should consider issuing press releases prior to analyst meetings and
conference calls and scripting those meetings and calls to decrease the chance
that further information will be disclosed.
Firewall elements: An
information barrier commonly referred to as a "firewall" is the most
widely used approach to prevent communication of material nonpublic information
within firms. The minimum elements of such a system include, but are not
limited to, the following:
Substantial control of relevant
interdepartmental communications, preferably through a clearance area within
the firm in either the compliance or legal department.
Review of employee trading through
the maintenance of "watch," 'i•estricted," and "rumor"
lists.
Documentation of the procedures
designed to limit the flow of information between departments and of the
enforcement actions taken pursuant to those procedures. 
Heightened review or restriction of proprietary trading
while a firm is in possession of material nonpublic information.
Appropriate
interdepartmental communications: Based on the size of the firm, procedures concerning
interdepartmental communication, the review of trading activity, and the
investigation of possible violations should be compiled and formalized.
Physical separation of departments: As a practical matter, to the extent
possible, firms should consider the physical separation of departments and
files to prevent the communication of sensitive information.
Prevention of personnel
overlap: There should be no overlap of personnel between the investment banking
and corporate finance areas of a brokerage firm and the sales and research
departments or between a bank's commercial lending department and its trust and
research departments. For a firewall to be effective in a multiservice firm, an
employee can be allowed to be on only one side of the wall at any given time.
A reporting
system: The least a firm should do to protect itself from liability is have an
information barrier in place. It should authorize people to review and approve
communications between departments. A single supen'isor or compliance officer
should have the specific authority and responsibility of deciding whether
information is material and whether it is sufficiently public to be used as the
basis for investment decisions.
Personal trading
limitations: Firms should also consider restrictions or prohibitions on
personal trading by employees and should carefully monitor both proprietary
trading and personal trading by employees. Further, they should require
employees to make periodic reports (to the extent that such reporting is not
already required by securities laws) of their own transactions and transactions
made for the benefit of family members.
Securities should be
placed on a restricted list when a firm has or may have material nonpublic
information. Further, the watch list should be shown to only the few people
responsible for compliance to monitor transactions in specified securities. The
use of a watch list in combination with a restricted list has become a common
means of ensuring an effective procedure.
Record maintenance:
Multiservice firms should maintain written records of communications among
various departments. Firms should place a high priority on training and should
consider instituting comprehensive training programs, to enable employees to
make informed decisions.
Proprietary trading
procedures: Procedures concerning the restriction or review of a firm's
proprietary trading while it possesses material nonpublic information will
necessarily depend on the types of proprietary trading in which a firm may
engage. For example, when a firm acts as a market maker, a prohibition on
proprietary trading may be counterproductive to the goals of maintaining the
confidentiality of information and market liquidity. However, in the case of
risk-arbitrage trading, a firm should suspend arbitrage activity when a
security is placed on the watch list.
Communication to
all employees: Written compliance policies and guidelines should be circulated
to all employees of a firm. Further, they must be given sufficient training to
either be able to make an informed decision or to realize that they need to
consult a compliance officer before engaging in questionable transactions.
Application of the Standard
Example 1
(Acting on Nonpublic Information)
Frank Barnes, the president and
controlling shareholder of the SmartTown clothing chain, decides to accept a
tender offer and sell the family business at a price almost double the market
price of its shares. He describes this decision to his sister (SmartTown's
treasurer), who conveys it to her daughter (who owns no stock in the family
company at present), who tells her husband, Staple. Staple, however, tells
his stockbroker, Alex Halsey, who immediately buys SmartTown stock for
himself.
Comment:
The information regarding the pending sale is both material and nonpublic.
Staple has violated Standard Il(A) by communicating the inside information to
his broker. Halsey also has violated the standard by buying the shares on the
basis of material nonpublic information.
Example 2 (Controlling Nonpublic
Information)
Samuel Peter, an analyst with
Scotland and Pierce Incorporated, is assisting his firm with a secondary
offering for Bright Ideas Lamp Company. Peter participates, via telephone
conference call, in a meeting with Scotland and Pierce investment banking employees
and Bright Ideas' CEO. Peter is advised that the company's earnings projections
for the next year have significantly dropped. Throughout the telephone
conference call, several Scotland and Pierce salespeople and portfolio managers
walk in and out of Peter's office, where the telephone call is taking place. As
a result, they are aware of the drop in projected earnings for Bright Ideas.
Before the conference call is concluded, the salespeople trade the stock of the
company on behalf of the firm's clients and other firm personnel trade the
stock in a firm proprietary account and in employees' personal accounts.
Comment: Peter has violated Standard Il(A) because he failed
to prevent the transfer and misuse of material nonpublic information to others
in his firm. Peter's firm should have adopted information barriers to prevent
the communication of nonpublic information among departments of the firm. The
salespeople and portfolio managers who traded on the information have also
violated Standard Il(A) by trading on inside information.
Example
3 (Selective Disclosure of Material Information)
Elizabeth
Levenson is based in Taipei and covers the Taiwanese market for her firm, which
is based in Singapore. She is invited, together with the other 10 largest
shareholders of a manufacturing company, to meet the finance director of that
company. During the meeting, the finance director states that the company
expects its workforce to strike next Friday, which will cripple productivity
and distribution. Can Levenson use this information as a basis to change her
rating on the company from "buy" to "sell"?
Comment:
Levenson must first determine whether the material information is public.
According to Standard Il(A), if the company has not made this information
public (a small group forum does not qualify as a method of public
dissemination), she cannot use the information.
Example 4 (Determining
Materiality)
Leah Fechtman is trying to decide whether to hold or sell shares of an
oil-and-gas exploration company that she owns in several of the funds she
manages. Although the company has underperformed the index for some time already,
the trends in the industry sector signal that companies of this type might
become takeover targets. While she is considering her decision, her doctor, who
casually follows the markets, mentions that she thinks that the company in
question will soon be bought out by a large multinational conglomerate and that
it would be a good idea to buy the stock right now. After talking to various
investment professionals and checking their opinions on the company as well as
checking industry trends, Fechtman decides the next day to accumulate more
stock in the oil-and-gas exploration company.
Comment: Although information on
an expected takeover bid may be of the type that is generally material and
nonpublic, in this case, the source of information is unreliable, so the
information cannot be considered material. Therefore, Fechtman is not
prohibited from trading the stock on the basis of this information.
Example
5 (Applying the Mosaic Theory)
Jagdish Teja is a buy-side analyst
covering the furniture industry. Looking for an attractive company to recommend
as a buy, he analyzes several furniture makers by studying their financial
reports and visiting their operations. He also talks to some designers and
retailers to find out which furniture styles are trendy and popular. Although
none of the companies that he analyzes are a clear buy, he discovers that one
of them, Swan Furniture Company (SFC), may be in financial trouble. SFC's
extravagant new designs have been introduced at substantial cost. Even though
these designs initially
©
attracted
attention, the public is now buying more conservative furniture from other
makers. Based on this information and on a profit-and-loss analysis, Teja
believes that SFC's next quarter earnings will drop substantially. He issues a
sell recommendation for SFC. Immediately after receiving that recommendation,
investment managers start reducing the SFC stock in their portfolios.
Comment:
Information on quarterly earnings data is material and nonpublic. Teja arrived
at his conclusion about the earnings drop on the basis of public information
and on pieces of nonmaterial nonpublic information (such as opinions of
designers and retailers). Therefore, trading based on Teja's correct conclusion
is not prohibited by Standard Il(A).
Tom Stafford is part of a team
within Appleton Investment Management responsible for managing a pool of assets
for Open Air Bank, which distributes structured securities to offshore clients.
He becomes aware that Open Air is promoting the structured securities as a much
less risky investment than the investment management policy followed by him and
the team to manage the original pool of assets. Also, Open Air has procured an
independent rating for the pool that significantly overstates the quality of
the investments. Stafford communicates his concerns to his supervisor, who
responds that Open Air owns the product and is responsible for all marketing
and distribution. Stafford's supervisor goes on to say that the product is
outside of the U S. regulatory regime that Appleton follows and that all risks
of the product are disclosed at the bottom of page 184 of the prospectus.
Comment: As a member of the
investment team, Stafford is qualified to recognize the degree of accuracy of
the materials that characterize the portfolio, and he is correct to be worried
about Appleton's responsibility for a misrepresentation of the risks. Thus, he
should continue to pursue the issue of Open Air's inaccurate promotion of the
portfolio according to the firm's policies and procedures.
The Code and Standards stress
protecting the reputation of the firm and the sustainability and integrity of
the capital markets. Misrepresenting the quality and risks associated with the
investment pool may lead to negative consequences for others well beyond the
direct investors.
Example 11 (Misrepresenting
Composite Construction)
Robert Palmer is head of
performance for a fund manager. When asked to provide performance numbers to
fund rating agencies, he avoids mentioning that the fund manager is quite
liberal in composite construction. The reason accounts are included/ excluded is
not fully explained. The performance values reported to the rating agencies for
the composites, although accurate for the accounts shown each period, may not
present a true representation of the fund manager's ability.
Comment: "Cherry
picking" accounts to include in either published reports or information
provided to rating agencies conflicts with Standard I(C). Moving accounts into
or out of a composite to influence the overall performance results materially
misrepresents the reported values over time. Palmer should work with his firm
to strengthen its reporting practices concerning composite construction to
avoid misrepresenting the firm's track record or the quality of the information
being provided.
Example 12 (Overemphasis of Firm Results)
|
Bob Anderson is chief compliance officer for Optima Asset Management Company, a
firm currently offering eight funds to clients. Seven of the eight had 10-year
returns below the median for their respective sectors. Anderson approves a
recent advertisement, which includes this statement: "Optima Asset
Management is achieving excellent returns for its investors. The Optima
Emerging Markets Equity fund, for example, has 10-year returns that exceed the
sector median by more than 10%."
Comment: From the information provided it is difficult to
determine whether a violation has occurred as long as the sector outperformance
is correct. Anderson may be attempting to mislead potential clients by citing
the performance of the sole fund that achieved such results. Past performance
is often used to demonstrate a firm's skill and abilities in comparison to
funds in the same sectors.
However, if all
the funds outperformed their respective benchmarks, then Anderson 's assertion
that the company "is achieving excellent returns" may be factual.
Funds may exhibit positive returns for investors, exceed benchmarks, and yet
have returns below the median in their sectors.
Members and candidates need to ensure that their marketing
efforts do not include statements that misrepresent their skills and abilities
to remain compliant with Standard I(C). Unless the returns of a single fund
reflect the performance of a firm as a whole, the use of a singular fund for
performance comparisons should be avoided.
Standard I(D) Misconduct
The Standard
Members and candidates
must not engage in any professional conduct involving dishonesty, fraud, or
deceit, or commit any act that reflects adversely on their professional
reputation, integrity, or competence.
Guidance
While Standard I(A) addresses the
obligation of members and candidates to comply with applicable law that governs
their professional activities, Standard I(D) addresses all conduct that
reflects poorly on the professional integrity, good reputation, or competence
of members and candidates. Any act that involves lying, cheating, stealing, or
other dishonest conduct is a violation of this standard if the offense reflects
adversely on a member's or candidate's professional activities.
Conduct that damages
trustworthiness or competence may include behavior that, although not illegal,
nevertheless negatively affects a member's or candidate's ability to perform
his or her responsibilities. For example:
Abusing alcohol during business hours might
constitute a violation of this standard because it could have a detrimental
effect on the member's or candidate's ability to fulfill his or her
professional responsibilities.
Personal bankruptcy may not
reflect on the integrity or trustworthiness of the person declaring bankruptcy,
but if the circumstances of the bankruptcy involve fraudulent or deceitful
business conduct, the bankruptcy may be a violation of this standard.
|
In some cases, the absence of appropriate conduct or the lack of sufficient
effort may be a violation of Standard I(D). The integrity of the investment
profession is built on trust. A member or candidate—whether an investment
banker, rating or research analyst, or portfolio manager—is expected to conduct
the necessary due diligence to properly understand the nature and risks of an
investment before making an investment recommendation. By not taking these
steps and, instead, relying on someone else in the process to perform them,
members or candidates may violate the trust their clients have placed in them.
This loss of trust may have a significant impact on the reputation of the
member or candidate and the operations of the financial market as a whole.
Note that Standard I(D) or any
other standard should not be used to settle personal, political, or other
disputes unrelated to professional ethics.
Recommended Procedures for
Compliance
Members and candidates
should encourage their firms to adopt the following policies and procedures to
support the principles of Standard I(D):
Code of ethics: Develop and/or
adopt a code of ethics to which every employee must subscribe, and make clear
that any personal behavior that reflects poorly on the individual involved, the
institution as a whole, or the investment industry will not be tolerated.
List of violations: Disseminate to
all employees a list of potential violations and associated disciplinary
sanctions, up to and including dismissal from the firm. Employee references: Check references of
potential employees to ensure that they are of good character and not
ineligible to work in the investment industry because of past infractions of
the law.
Application of the
Standard
Example
1 (Professionalism and Competence)
Simon
Sasserman is a trust investment officer at a bank in a small affluent town. He
enjoys lunching every day with friends at the country club, where his clients
have observed him having numerous drinks. Back at work after lunch, he clearly
is intoxicated while making investment
decisions. His colleagues make a point of handling any business with Sasserman
in the morning because they distrust his judgment after lunch.
Comment: Sasserman's excessive drinking at
lunch and subsequent intoxication at work constitute a violation of Standard
I(D) because this conduct has raised questions about his professionalism and
competence. His behavior reflects poorly on him, his employer, and the
investment industry.
Example
2 (Fraud and Deceit)
Howard
Hoffman, a security analyst at ATZ Brothers, Inc., a large brokerage house,
submits reimbursement forms over a two-year period to ATZ's self-funded health
insurance program for more than two dozen bills, most of which have been
altered to increase the amount due. An investigation by the firm's director of
employee benefits uncovers the inappropriate conduct. ATZ subsequently
terminates Hoffman's employment and notifies CFA Institute.
Comment:
Hoffman violated Standard I(D) because he engaged in intentional conduct
involving fraud and deceit in the workplace that adversely reflected on his
integrity.
|
Example 3 (Personal Actions and Integrity)
Carmen Garcia manages a mutual fund dedicated to socially
responsible investing. She is also an environmental activist. As the result of
her participation in nonviolent protests, Garcia has been arrested on numerous
occasions for trespassing on the property of a large petrochemical plant that
is accused of damaging the environment.
Comment: Generally, Standard I(D) is not meant to cover legal
transgressions resulting from acts of civil disobedience in support of personal
beliefs because such conduct does not reflect poorly on the member's or
candidate's professional reputation, integrity, or competence.
Example 4 (Professional
Misconduct)
Meredith Rasmussen works on a buy-side trading desk of
an investment management firm and concentrates on in-house trades for a hedge
fund subsidiary managed by a team at the investment management firm. The hedge
fund has been very successful and is marketed globally by the firm. From her
experience as the trader for much of the activity of the fund, Rasmussen has
become quite knowledgeable about the hedge fund's strategy, tactics, and
performance. When a distinct break in the market occurs and many of the
securities involved in the hedge fund's strategy decline markedly in value,
Rasmussen observes that the reported performance of the hedge fund does not
reflect this decline. In her experience, the lack of effect is a very unlikely
occurrence. She approaches the head of trading about her concern and is told
that she should not ask any questions and that the fund is big and successful
and is not her concern. She is fairly sure something is not right, so she
contacts the compliance officer, who also tells her to stay away from the issue
of the hedge fund's reporting.
Comment: Misconduct covers any activity that violates the Code
and Standards. In this case, Rasmussen suspects supervisors in the firm are
knowingly misreporting performance and violating the Code and Standards. While
she is under no obligation to report the misconduct unless required by
applicable law, she must dissociate herself with the activity, and, due to the
compliance officer's response to her report, she should consider reporting the
activity to regulatory authorities. She should thoroughly document her attempts
to dissociate herself and report the activity to supervisors and the compliance
officer along with any further action she pursues. Documenting the activity may
provide shelter should she be blamed in some way for a role in the misconduct.
See also Standard IV(A) for guidance on whistleblowing.
LESSON 2: STANDARD 11:
INTEGRITY OF CAPITAL MARKET
Material Nonpublic
Information
B. Market Manipulation
Standard Il(A) Material
Nonpublic Information
The Standard
Members and candidates
who possess material nonpublic information that could affect the value of an
investment must not act or cause others to act on the information.
Guidance
•
|
Standard Il(A) is related to information that is material and is nonpublic. Such
information must not be used for direct buying and selling of individual
securities or bonds, nor to influence investment actions related to
derivatives, mutual funds, or other alternative investments.
Material Information
Information is
"material" if its disclosure would likely have an impact on the price
of a security, or if reasonable investors would want to know the information
before making an investment decision. Material information may include, but is
not limited to, information relating to the following:
•
Earnings.
•
Mergers, acquisitions,
tender offers, or joint ventures.
•
Changes in assets.
•
Innovative products,
processes, or discoveries.
•
New licenses, patents,
registered trademarks, or regulatory approval/rejection of a product.
•
Developments regarding
customers or suppliers (e.g., the acquisition or loss of a contract).
•
Changes in management.
•
Change in auditor
notification or the fact that the issuer may no longer rely on an auditor's
report or qualified opinion.
•
Events regarding the
issuer's securities (e.g., defaults on senior securities, calls of securities
for redemption, repurchase plans, stock splits, changes in dividends, changes
to the rights of security holders, public or private sales of additional securities,
and changes in credit ratings).
•
Bankruptcies.
•
Significant legal disputes.
•
Government reports of
economic trends (employment, housing starts, currency information, etc.).
•
Orders for large trades
before they are executed.
•
New or changing equity or debt
ratings issued by a third party (e.g., sell-side recommendations and credit
ratings).
•
To determine if information
is material, members and candidates should consider the source of information
and the information's likely effect on the relevant stock price. The less reliable a source, the less likely
the information provided would be considered material.
•
The more ambiguous the
effect on price, the less material the information becomes.
If it is unclear whether the information will
affect the price of a security and to what extent, information may not be
considered material.
Nonpublic Information
•
Information is
"nonpublic" until it has been disseminated or is available to the
marketplace in general (as opposed to a select group of investors).
"Disseminated" can be defined as ''made known."
For example, a company report of profits that
is posted on the Internet and distributed widely through a press release or
accompanied by a filing has been effectively disseminated to the marketplace.
•
|
Members and candidates must be particularly aware of information that is
selectively disclosed by corporations to a small group of investors, analysts,
or other market participants. Information that is made available to analysts
remains nonpublic until it is made available to investors in general.
•
Analysts should also be
alert to the possibility that they are selectively receiving material nonpublic
information when a company provides them with guidance or interpretation of
such publicly available information as financial statements or regulatory
filings.
•
A member or candidate may
use insider information provided legitimately by the source company for the
specific purpose of conducting due diligence according to the business
agreement between the parties for such activities as mergers, loan
underwriting, credit ratings, and offering engagements. However, the use of
insider information provided by the source company for other purposes,
especially to trade or entice others to trade the securities of the firm,
conflicts with this standard.
Mosaic Theory
•
A financial analyst may use
significant conclusions derived from the analysis of public information and
nonmaterial nonpublic information as the basis for investment recommendations
and decisions. Under the "mosaic theory," financial analysts are free
to act on this collection, or mosaic, of information without risking violation,
even when the conclusion they reach would have been material inside information
had the company communicated the same.
•
Investment professionals
should note, however, that although analysts are free to use mosaic information
in their research reports, they should save and document all their research
[see Standard V(C)].
Social Media
•
Members and candidates
participating in online discussion forums/groups with membership limitations
should verify that material information obtained from these sources can also be
accessed from a source that would be considered available to the public (e.g.,
company filings, webpages, and press releases).
•
Members and candidates may
use social media platforms to communicate with clients or investors without
conflicting with this standard.
•
Members and candidates, as
required by Standard I(A), should also complete all appropriate regulatory
filings related to information distributed through social media platforms.
Using Industry Experts
•
The increased demand for
insights for understanding the complexities of some industries has led to an
expansion of engagement with outside experts. Members and candidates may
provide compensation to individuals for their insights without violating this
standard.
•
However, members and
candidates are ultimately responsible for ensuring that they are not requesting
or acting on confidential information received from external experts, which is
in violation of security regulations and laws or duties to others.
Investment Research Reports
•
|
It might often be the case that reports prepared by well-known analysts may
have an effect on the market and thus may be considered material information.
Theoretically, such a report might have to be made public before it was
distributed to clients. However, since the analyst is not a company insider,
and presumably prepared the report based on publicly available information, the
report does not need to be made public just because its conclusions are
material. Investors who want to use that report must become clients of the
analyst.
Recommended Procedures for
Compliance
Achieve public
dissemination: If a member or candidate determines that some nonpublic
information is material, she should encourage the issuer to make the
information public. If public dissemination is not possible, she must
communicate the information only to the designated supervisory and compliance
personnel in her firm and must not take investment action on the basis of the
information.
Adopt compliance
procedures: Members and candidates should encourage their firms to adopt
compliance procedures to prevent the misuse of material nonpublic information.
Particularly important is improving compliance in areas such as review of
employee and proprietary trading, documentation of firm procedures, and the
supervision of interdepartmental communications in multiservice firms.
Adopt disclosure
procedures: Members and candidates should encourage their firms to develop and
follow disclosure policies designed to ensure that information is disseminated
in the marketplace in an equitable manner. An issuing company should not discriminate
among analysts in the provision of information or blackball particular analysts
who have given negative reports on the company in the past.
Issue press releases:
Companies should consider issuing press releases prior to analyst meetings and
conference calls and scripting those meetings and calls to decrease the chance
that further information will be disclosed.
Firewall elements: An
information barrier commonly referred to as a "firewall" is the most
widely used approach to prevent communication of material nonpublic information
within firms. The minimum elements of such a system include, but are not
limited to, the following:
Substantial control of relevant
interdepartmental communications, preferably through a clearance area within
the firm in either the compliance or legal department.
Review of employee trading through
the maintenance of "watch," 'i•estricted," and "rumor"
lists.
Documentation of the procedures
designed to limit the flow of information between departments and of the
enforcement actions taken pursuant to those procedures. Heightened review or restriction of proprietary trading
while a firm is in possession of material nonpublic information.
Appropriate
interdepartmental communications: Based on the size of the firm, procedures concerning
interdepartmental communication, the review of trading activity, and the
investigation of possible violations should be compiled and formalized.
|
Physical separation of departments: As a practical matter, to the extent
possible, firms should consider the physical separation of departments and
files to prevent the communication of sensitive information.
Prevention of personnel
overlap: There should be no overlap of personnel between the investment banking
and corporate finance areas of a brokerage firm and the sales and research
departments or between a bank's commercial lending department and its trust and
research departments. For a firewall to be effective in a multiservice firm, an
employee can be allowed to be on only one side of the wall at any given time.
A reporting
system: The least a firm should do to protect itself from liability is have an
information barrier in place. It should authorize people to review and approve
communications between departments. A single supen'isor or compliance officer
should have the specific authority and responsibility of deciding whether
information is material and whether it is sufficiently public to be used as the
basis for investment decisions.
Personal trading
limitations: Firms should also consider restrictions or prohibitions on
personal trading by employees and should carefully monitor both proprietary
trading and personal trading by employees. Further, they should require
employees to make periodic reports (to the extent that such reporting is not
already required by securities laws) of their own transactions and transactions
made for the benefit of family members.
Securities should be
placed on a restricted list when a firm has or may have material nonpublic
information. Further, the watch list should be shown to only the few people
responsible for compliance to monitor transactions in specified securities. The
use of a watch list in combination with a restricted list has become a common
means of ensuring an effective procedure.
Record maintenance:
Multiservice firms should maintain written records of communications among
various departments. Firms should place a high priority on training and should
consider instituting comprehensive training programs, to enable employees to
make informed decisions.
Proprietary trading
procedures: Procedures concerning the restriction or review of a firm's
proprietary trading while it possesses material nonpublic information will
necessarily depend on the types of proprietary trading in which a firm may
engage. For example, when a firm acts as a market maker, a prohibition on
proprietary trading may be counterproductive to the goals of maintaining the
confidentiality of information and market liquidity. However, in the case of
risk-arbitrage trading, a firm should suspend arbitrage activity when a
security is placed on the watch list.
Communication to
all employees: Written compliance policies and guidelines should be circulated
to all employees of a firm. Further, they must be given sufficient training to
either be able to make an informed decision or to realize that they need to
consult a compliance officer before engaging in questionable transactions.
|
Application of the Standard
|
Example 1
(Acting on Nonpublic Information) Frank Barnes, the president and
controlling shareholder of the SmartTown clothing chain, decides to accept a
tender offer and sell the family business at a price almost double the market
price of its shares. He describes this decision to his sister (SmartTown's
treasurer), who conveys it to her daughter (who owns no stock in the family
company at present), who tells her husband, Staple. Staple, however, tells
his stockbroker, Alex Halsey, who immediately buys SmartTown stock for
himself. Comment:
The information regarding the pending sale is both material and nonpublic.
Staple has violated Standard Il(A) by communicating the inside information to
his broker. Halsey also has violated the standard by buying the shares on the
basis of material nonpublic information. |
Example 2 (Controlling Nonpublic
Information)
Samuel Peter, an analyst with
Scotland and Pierce Incorporated, is assisting his firm with a secondary
offering for Bright Ideas Lamp Company. Peter participates, via telephone
conference call, in a meeting with Scotland and Pierce investment banking employees
and Bright Ideas' CEO. Peter is advised that the company's earnings projections
for the next year have significantly dropped. Throughout the telephone
conference call, several Scotland and Pierce salespeople and portfolio managers
walk in and out of Peter's office, where the telephone call is taking place. As
a result, they are aware of the drop in projected earnings for Bright Ideas.
Before the conference call is concluded, the salespeople trade the stock of the
company on behalf of the firm's clients and other firm personnel trade the
stock in a firm proprietary account and in employees' personal accounts.
Comment: Peter has violated Standard Il(A) because he failed
to prevent the transfer and misuse of material nonpublic information to others
in his firm. Peter's firm should have adopted information barriers to prevent
the communication of nonpublic information among departments of the firm. The
salespeople and portfolio managers who traded on the information have also
violated Standard Il(A) by trading on inside information.
Example
3 (Selective Disclosure of Material Information)
Elizabeth
Levenson is based in Taipei and covers the Taiwanese market for her firm, which
is based in Singapore. She is invited, together with the other 10 largest
shareholders of a manufacturing company, to meet the finance director of that
company. During the meeting, the finance director states that the company
expects its workforce to strike next Friday, which will cripple productivity
and distribution. Can Levenson use this information as a basis to change her
rating on the company from "buy" to "sell"?
Comment:
Levenson must first determine whether the material information is public.
According to Standard Il(A), if the company has not made this information
public (a small group forum does not qualify as a method of public
dissemination), she cannot use the information.
Example 4 (Determining
Materiality)
|
Leah Fechtman is trying to decide whether to hold or sell shares of an
oil-and-gas exploration company that she owns in several of the funds she
manages. Although the company has underperformed the index for some time already,
the trends in the industry sector signal that companies of this type might
become takeover targets. While she is considering her decision, her doctor, who
casually follows the markets, mentions that she thinks that the company in
question will soon be bought out by a large multinational conglomerate and that
it would be a good idea to buy the stock right now. After talking to various
investment professionals and checking their opinions on the company as well as
checking industry trends, Fechtman decides the next day to accumulate more
stock in the oil-and-gas exploration company.
Comment: Although information on
an expected takeover bid may be of the type that is generally material and
nonpublic, in this case, the source of information is unreliable, so the
information cannot be considered material. Therefore, Fechtman is not
prohibited from trading the stock on the basis of this information.
Example
5 (Applying the Mosaic Theory)
Jagdish Teja is a buy-side analyst
covering the furniture industry. Looking for an attractive company to recommend
as a buy, he analyzes several furniture makers by studying their financial
reports and visiting their operations. He also talks to some designers and
retailers to find out which furniture styles are trendy and popular. Although
none of the companies that he analyzes are a clear buy, he discovers that one
of them, Swan Furniture Company (SFC), may be in financial trouble. SFC's
extravagant new designs have been introduced at substantial cost. Even though
these designs initially
©
attracted
attention, the public is now buying more conservative furniture from other
makers. Based on this information and on a profit-and-loss analysis, Teja
believes that SFC's next quarter earnings will drop substantially. He issues a
sell recommendation for SFC. Immediately after receiving that recommendation,
investment managers start reducing the SFC stock in their portfolios.
Comment:
Information on quarterly earnings data is material and nonpublic. Teja arrived
at his conclusion about the earnings drop on the basis of public information
and on pieces of nonmaterial nonpublic information (such as opinions of
designers and retailers). Therefore, trading based on Teja's correct conclusion
is not prohibited by Standard Il(A).
Example 6
(Mosaic Theory)
John Doll is a research analyst for a hedge fund that also sells its research
to a select group of paying client investment firms. Doll's focus is medical
technology companies and products, and he has been in the business long enough
and has been successful enough to build up a very credible network of friends
and experts in the business. Doll has been working on a major research report
recommending Boyce Health, a medical device manufacturer. He recently ran into
an old acquaintance at a wedding who is a senior executive at Boyce, and Doll
asked about the business. Doll was drawn to a statement that the executive, who
has responsibilities in the new products area, made about a product: "I
would not get too excited about the medium-term prospects; we have a lot of
work to do first." Doll incorporated this and other information about the
new Boyce product in his long-term recommendation of Boyce.
Comment: Doll's conversation with the senior executive is part
of the mosaic of information used in recommending Boyce. When holding
discussions with a firm executive, Doll would need to guard against soliciting
or obtaining material nonpublic information. Before issuing the report, the
executive's statement about the continuing development of the product would
need to be weighed against the other known public facts to determine whether it
would be considered material.
|
John Doll is a research analyst for a hedge fund that also sells its research
to a select group of paying client investment firms. Doll's focus is medical
technology companies and products, and he has been in the business long enough
and has been successful enough to build up a very credible network of friends
and experts in the business. Doll has been working on a major research report
recommending Boyce Health, a medical device manufacturer. He recently ran into
an old acquaintance at a wedding who is a senior executive at Boyce, and Doll
asked about the business. Doll was drawn to a statement that the executive, who
has responsibilities in the new products area, made about a product: "I
would not get too excited about the medium-term prospects; we have a lot of
work to do first." Doll incorporated this and other information about the
new Boyce product in his long-term recommendation of Boyce.
Comment: Doll's conversation with the senior executive is part
of the mosaic of information used in recommending Boyce. When holding
discussions with a firm executive, Doll would need to guard against soliciting
or obtaining material nonpublic information. Before issuing the report, the
executive's statement about the continuing development of the product would
need to be weighed against the other known public facts to determine whether it
would be considered material.
Example
7 (Materiality Determination)
Larry
Nadler, a trader for a mutual fund, gets a text message from another firm's
trader, whom he has known for years. The message indicates a software company
is going to report strong earnings when the firm publicly announces in two
days. Nadler has a buy order from a portfolio manager within his firm to
purchase several hundred thousand shares of the stock. Nadler is aggressive in
placing the portfolio manager's order and completes the purchases by the
following morning, a day ahead of the firm's planned earnings announcement.
Comment: There are often rumors and whisper numbers before a
release of any kind. The text message from the other trader would most likely
be considered market noise. Unless Nadler knew that the trader had an ongoing
business relationship with the public firm, he had no reason to suspect he was
receiving material nonpublic information that would prevent him from completing
the trading request of the portfolio manager.
Example 8 (Using an Expert Network)
Tom Watson is a research analyst working for a hedge fund. To
stay informed, Watson relies on outside experts for information on such
industries as technology and pharmaceuticals, where new advancements occur
frequently. The meetings with the industry experts often are arranged through
networks or placement agents that have specific policies and procedures in
place to deter the exchange of material nonpublic information.
Watson arranges a call to discuss future prospects for one of
the fund's existing technology company holdings, a company that was testing a
new semiconductor product. The scientist leading the tests indicates his
disappointment with the performance of the new semiconductor. Following the
call, Watson relays the insights he received to others at the fund. The fund
sells its current position in the company and writes many put options because
the market is anticipating the success of the new semiconductor and the share
price reflects the market's optimism.
Comment: Watson has violated Standard Il(A) by passing along material nonpublic
information concerning the ongoing product tests, which the fund used to trade
in the securities and options of the related company. Watson cannot simply rely
on the agreements signed by individuals who participate in expert networks that
state that he has not received information that would prohibit his trading
activity. He must make his own determination whether information he received
through these arrangements reaches a materiality threshold that would affect his
trading abilities.
Standard Il(B) Market
Manipulation
The Standard
Members and candidates
must not engage in practices that distort prices or artificially inflate
trading volume with the intent to mislead market participants.
Guidance
Members and candidates must uphold
market integrity by prohibiting market manipulation. Market manipulation
includes practices that distort security prices or trading volume with the
intent to deceive people or entities that rely on information in the market.
Market manipulation includes (l )
the dissemination of false or misleading information and (2) transactions that
deceive or would be likely to mislead market participants by distorting the
price-setting mechanism of financial instruments.
Information-Based
Manipulation
Information-based manipulation
includes, but is not limited to, spreading false rumors to induce trading by
others.
For example, members and candidates must
refrain from "pumping up" the price of an investment by issuing
misleading positive information or overly optimistic projections of a
security's worth only to later "dump" the investment (i.e., sell it)
once the price, fueled by the misleading information's effect on other market
participants, reaches an artificially high level.
Transaction-Based
Manipulation
Transaction-based manipulation
involves instances where a member or candidate knew or should have known that
his or her actions could affect the pricing of a security. This type of
manipulation includes, but is not limited to, the following:
Transactions that artificially
affect prices or volume to give the impression of activity or price movement in
a financial instrument, which represent a diversion from the expectations of a
fair and efficient market.
Securing a controlling, dominant position in a
financial instrument to exploit and manipulate the price of a related
derivative and/or the underlying asset.
Note that Standard Il(B)
is not intended to preclude transactions undertaken on legitimate trading
strategies based on perceived market inefficiencies. The intent of the action
is critical to determining whether it is a violation of this standard.
Application of the
Standard
Example 1 (Independent Analysis and Company Promotion)
The principal owner of Financial Information Services (FIS) entered into an
agreement with two microcap companies to promote the companies' stock in
exchange for stock and cash compensation. The principal owner caused FIS to
disseminate e-mails, design and maintain several websites, and distribute an
online investment newsletter—all of which recommended investment in the two
companies. The systematic publication of purportedly independent analyses and
recommendations containing inaccurate and highly promotional and speculative
statements increased public investment in the companies and led to dramatically
higher stock prices.
Comment: The principal owner of FIS violated Standard Il(B) by
using inaccurate reporting and misleading information under the guise of
independent analysis to artificially increase the stock price of the companies.
Furthermore, the principal owner violated Standard V(A)—Diligence and
Reasonable Basis by not having a reasonable and adequate basis for recommending
the two companies and violated Standard VI(A)— Disclosure of Conflicts by not
disclosing to investors the compensation agreements (which constituted a
conflict of interest).
Larry
Nadler, a trader for a mutual fund, gets a text message from another firm's
trader, whom he has known for years. The message indicates a software company
is going to report strong earnings when the firm publicly announces in two
days. Nadler has a buy order from a portfolio manager within his firm to
purchase several hundred thousand shares of the stock. Nadler is aggressive in
placing the portfolio manager's order and completes the purchases by the
following morning, a day ahead of the firm's planned earnings announcement.
Comment: There are often rumors and whisper numbers before a
release of any kind. The text message from the other trader would most likely
be considered market noise. Unless Nadler knew that the trader had an ongoing
business relationship with the public firm, he had no reason to suspect he was
receiving material nonpublic information that would prevent him from completing
the trading request of the portfolio manager.
Example 8 (Using an Expert Network)
Tom Watson is a research analyst working for a hedge fund. To
stay informed, Watson relies on outside experts for information on such
industries as technology and pharmaceuticals, where new advancements occur
frequently. The meetings with the industry experts often are arranged through
networks or placement agents that have specific policies and procedures in
place to deter the exchange of material nonpublic information.
Watson arranges a call to discuss future prospects for one of
the fund's existing technology company holdings, a company that was testing a
new semiconductor product. The scientist leading the tests indicates his
disappointment with the performance of the new semiconductor. Following the
call, Watson relays the insights he received to others at the fund. The fund
sells its current position in the company and writes many put options because
the market is anticipating the success of the new semiconductor and the share
price reflects the market's optimism.
|
Comment: Watson has violated Standard Il(A) by passing along material nonpublic
information concerning the ongoing product tests, which the fund used to trade
in the securities and options of the related company. Watson cannot simply rely
on the agreements signed by individuals who participate in expert networks that
state that he has not received information that would prohibit his trading
activity. He must make his own determination whether information he received
through these arrangements reaches a materiality threshold that would affect his
trading abilities.
Standard Il(B) Market
Manipulation
The Standard
Members and candidates
must not engage in practices that distort prices or artificially inflate
trading volume with the intent to mislead market participants.
Guidance
Members and candidates must uphold
market integrity by prohibiting market manipulation. Market manipulation
includes practices that distort security prices or trading volume with the
intent to deceive people or entities that rely on information in the market.
Market manipulation includes (l )
the dissemination of false or misleading information and (2) transactions that
deceive or would be likely to mislead market participants by distorting the
price-setting mechanism of financial instruments.
Information-Based
Manipulation
Information-based manipulation
includes, but is not limited to, spreading false rumors to induce trading by
others.
For example, members and candidates must
refrain from "pumping up" the price of an investment by issuing
misleading positive information or overly optimistic projections of a
security's worth only to later "dump" the investment (i.e., sell it)
once the price, fueled by the misleading information's effect on other market
participants, reaches an artificially high level.
Transaction-Based
Manipulation
Transaction-based manipulation
involves instances where a member or candidate knew or should have known that
his or her actions could affect the pricing of a security. This type of
manipulation includes, but is not limited to, the following:
Transactions that artificially
affect prices or volume to give the impression of activity or price movement in
a financial instrument, which represent a diversion from the expectations of a
fair and efficient market.
Securing a controlling, dominant position in a
financial instrument to exploit and manipulate the price of a related
derivative and/or the underlying asset.
Note that Standard Il(B)
is not intended to preclude transactions undertaken on legitimate trading
strategies based on perceived market inefficiencies. The intent of the action
is critical to determining whether it is a violation of this standard.
Application of the
Standard
Example 1 (Independent Analysis and Company Promotion)
|
The principal owner of Financial Information Services (FIS) entered into an
agreement with two microcap companies to promote the companies' stock in
exchange for stock and cash compensation. The principal owner caused FIS to
disseminate e-mails, design and maintain several websites, and distribute an
online investment newsletter—all of which recommended investment in the two
companies. The systematic publication of purportedly independent analyses and
recommendations containing inaccurate and highly promotional and speculative
statements increased public investment in the companies and led to dramatically
higher stock prices.
Comment: The principal owner of FIS violated Standard Il(B) by
using inaccurate reporting and misleading information under the guise of
independent analysis to artificially increase the stock price of the companies.
Furthermore, the principal owner violated Standard V(A)—Diligence and
Reasonable Basis by not having a reasonable and adequate basis for recommending
the two companies and violated Standard VI(A)— Disclosure of Conflicts by not
disclosing to investors the compensation agreements (which constituted a
conflict of interest).
Example 2
(Personal Trading Practices and Price)
John Gray is a private investor in Belgium who bought a large
position several years ago in Fame Pharmaceuticals, a German small-cap security
with limited average trading volume. He has now decided to significantly reduce
his holdings owing to the poor price performance. Gray is worried that the low
trading volume for the stock may cause the price to decline further as he
attempts to sell his large position.
Gray devises a plan to divide his holdings into multiple
accounts in different brokerage firms and private banks in the names of family
members, friends, and even a private religious institution. He then creates a
rumor campaign on various blogs and social media outlets promoting the company.
Gray begins to buy and sell the stock using the accounts in
hopes of raising the trading volume and the price. He conducts the trades
through multiple brokers, selling slightly larger positions than he bought on a
tactical schedule, and over time, he is able to reduce his holding as desired
without negatively affecting the sale price.
Comment: Gray violated Standard Il(B) by fraudulently creating the appearance
that there was a greater investor interest in the stock through the online
rumors. Additionally, through his trading strategy, he created the appearance
that there was greater liquidity in the stock than actually existed. He was
able to manipulate the price through both misinformation and trading practices.
Example 3
(Personal Trading and Volume)
Rajesh Sekar manages two
funds—an equity fund and a balanced fund—whose equity components are supposed
to be managed in accordance with the same model. According to that model, the
funds' holdings in stock of Digital Design Inc. (DD) are excessive. Reduction
of the DD holdings would not be easy, however, because the stock has low
liquidity in the stock market. Sekar decides to start trading larger portions
of DD stock back and forth between his two funds to slowly increase the
price; he believes market participants will see growing volume and increasing
price and become interested in the stock. If other investors are willing to
buy the DD stock because of such interest, then Sekar will be able to get rid
of at least some of his overweight position without inducing price decreases.
In this way, the whole transaction will be for the benefit of fund
participants, even if additional brokers' commissions are incurred.
Comment:
Sekar's plan would be beneficial for his funds' participants but is based on
artificial distortion of both trading volume and the price of the DD stock
and thus constitutes a violation of Standard Il(B).
John Gray is a private investor in Belgium who bought a large
position several years ago in Fame Pharmaceuticals, a German small-cap security
with limited average trading volume. He has now decided to significantly reduce
his holdings owing to the poor price performance. Gray is worried that the low
trading volume for the stock may cause the price to decline further as he
attempts to sell his large position.
Gray devises a plan to divide his holdings into multiple
accounts in different brokerage firms and private banks in the names of family
members, friends, and even a private religious institution. He then creates a
rumor campaign on various blogs and social media outlets promoting the company.
Gray begins to buy and sell the stock using the accounts in
hopes of raising the trading volume and the price. He conducts the trades
through multiple brokers, selling slightly larger positions than he bought on a
tactical schedule, and over time, he is able to reduce his holding as desired
without negatively affecting the sale price.
|
Comment: Gray violated Standard Il(B) by fraudulently creating the appearance
that there was a greater investor interest in the stock through the online
rumors. Additionally, through his trading strategy, he created the appearance
that there was greater liquidity in the stock than actually existed. He was
able to manipulate the price through both misinformation and trading practices.
|
Example 3
(Personal Trading and Volume) Rajesh Sekar manages two
funds—an equity fund and a balanced fund—whose equity components are supposed
to be managed in accordance with the same model. According to that model, the
funds' holdings in stock of Digital Design Inc. (DD) are excessive. Reduction
of the DD holdings would not be easy, however, because the stock has low
liquidity in the stock market. Sekar decides to start trading larger portions
of DD stock back and forth between his two funds to slowly increase the
price; he believes market participants will see growing volume and increasing
price and become interested in the stock. If other investors are willing to
buy the DD stock because of such interest, then Sekar will be able to get rid
of at least some of his overweight position without inducing price decreases.
In this way, the whole transaction will be for the benefit of fund
participants, even if additional brokers' commissions are incurred. Comment:
Sekar's plan would be beneficial for his funds' participants but is based on
artificial distortion of both trading volume and the price of the DD stock
and thus constitutes a violation of Standard Il(B). |
Example
4 ("Pump-Priming" Strategy)
Sergei Gonchar is chairman of the
ACME Futures Exchange, which is launching a new bond futures contract. To
convince investors, traders, arbitrageurs, hedgers, and so on, to use its
contract, the exchange attempts to demonstrate that it has the best liquidity.
To do so, it enters into agreements with members in which they commit to a
substantial minimum trading volume on the new contract over a specific period
in exchange for substantial reductions of their regular commissions.
Comment: The formal liquidity of a
market is determined by the obligations set on market makers, but the actual
liquidity of a market is better estimated by the actual trading volume and
bid—ask spreads. Attempts to mislead participants about the actual liquidity of
the market constitute a violation of Standard Il(B). In this example, investors
have been intentionally misled to believe they chose the most liquid instrument
for some specific purpose, but they could eventually see the actual liquidity
of the contract significantly reduced after the term of the agreement expires.
If the ACME Futures Exchange fully discloses its agreement with members to
boost transactions over some initial launch period, it will not violate
Standard Il(B). ACME's intent is not to harm investors but, on the contrary, to
give them a better service. For that purpose, it may engage in a
liquidity-pumping strategy, but the strategy must be disclosed.
Example 5
(Pump and Dump Stratekv)
In an effort to pump up the price
of his holdings in Moosehead & Belfast Railroad Company, Steve Weinberg
logs on to several investor chat rooms on the Internet to start rumors that the
company is about to expand its rail network in anticipation of receiving a
large contract for shipping lumber.
Comment: Weinberg has violated
Standard Il(B) by disseminating false information about Moosehead & Belfast
with the intent to mislead market participants.
Example
6 (Information Manipulation)
Allen
King is a performance analyst for Torrey Investment Funds. King believes that
the portfolio manager for the firm's small- and microcap equity fund dislikes
him because the manager never offers him tickets to the local baseball team's
games but does offer tickets to other employees. To incite a potential
regulatory review of the manager, King creates user profiles on several online
forums under the portfolio manager's name and starts rumors about potential
mergers for several of the smaller companies in the portfolio. As the prices of
these companies' stocks increase, the portfolio manager sells the position,
which leads to an investigation by the regulator as King desired.
Comment: King has violated Standard Il(B) even though he did not personally profit
from the market's reaction to the rumor. In posting the false information, King
misleads others into believing the companies were likely to be acquired.
Although his intent was to create trouble for the portfolio manager, his
actions clearly manipulated the factual information that was available to the
market.
LESSON 3: STANDARD 111:
DUTIES TO CLIENTS
Loyalty, Prudence, and Care
B. Fair Dealing
c. Suitability
D. Performance Presentation
E. Preservation of Confidentiality
Standard Ill(A) Loyalty,
Prudence, and Care
The Standard
Members and candidates
have a duty of loyalty to their clients and must act with reasonable care and
exercise prudent judgment. Members and candidates must act for the benefit of
their clients and place their clients' interests before their employer's or their
own interests.
Guidance
•
Standard Ill(A) clarifies
that client interests are paramount. A member's or candidate's responsibility
to a client includes a duty of loyalty and a duty to exercise reasonable care.
Investment actions must be carried out for the sole benefit of the client and
in a manner the member or candidate believes, given the known facts and
circumstances, to be in the best interest of the client. Members and candidates
must exercise the same level of prudence, judgment, and care that they would
apply in the management and disposition of their own interests in similar
circumstances.
•
Prudence requires caution
and discretion. The exercise of prudence by investment professionals requires
that they act with the care, skill, and diligence that a reasonable person
acting in a like capacity and familiar with such matters would use. In the context
of managing a client's portfolio, prudence requires following the investment
parameters set forth by the client and balancing risk and return. Acting with
care requires members and candidates to act in a prudent and judicious manner
in avoiding harm to clients.
•
Standard Ill(A), however,
is not a substitute for a member's or candidate's legal or regulatory
obligations. As stated in Standard (A), members and candidates must abide by
the most strict requirements imposed on them by regulators or the Code and
Standards, including any legally imposed fiduciary duty.
•
Members and candidates must
also be aware of whether they have "custody" or effective control of
client assets. If so, a heightened level of responsibility arises. Members and
candidates are considered to have custody if they have any direct or indirect
access to client funds. Members and candidates must manage any pool of assets
in their control in accordance with the terms of the governing documents (such
as trust documents and investment management agreements), which are the primary
determinant of the manager's powers and duties.
Understanding the
Application of Loyalty, Prudence, and Care
•
Standard Ill(A) establishes a minimum benchmark for the duties of loyalty,
prudence, and care that are required of all members and candidates regardless
of whether a legal fiduciary duty applies. Although fiduciary duty often
encompasses the principles of loyalty, prudence, and care, Standard Ill(A) does
not render all members and candidates fiduciaries. The responsibilities of
members and candidates for fulfilling their obligations under this standard
depend greatly on the nature of their professional responsibilities and the
relationships they have with clients.
•
There is a large variety of
professional relationships that members and candidates have with their clients.
Standard Ill(A) requires them to fulfill the obligations outlined explicitly or
implicitly in the client agreements to the best of their abilities and with
loyalty, prudence, and care. Whether a member or candidate is structuring a new
securitization transaction, completing a credit rating analysis, or leading a
public company, he or she must work with prudence and care in delivering the
agreed-on services.
Identifying the Actual
Investment Client
•
The first step for members
and candidates in fulfilling their duty of loyalty to clients is to determine
the identity of the "client" to whom the duty of loyalty is owed. In
the context of an investment manager managing the personal assets of an
individual, the client is easily identified. When the manager is responsible
for the portfolios of pension plans or trusts, however, the client is not the
person or entity who hires the manager but, rather, the beneficiaries of the
plan or trust. The duty of loyalty is owed to the ultimate beneficiaries.
•
Members and candidates
managing a fund to an index or an expected mandate owe the duty of loyalty,
prudence, and care to invest in a manner consistent with the stated mandate.
The decisions of a fund's manager, although benefiting all fund investors, do
not have to be based on an individual investor's requirements and risk profile.
Client loyalty and care for those investing in the fund are the responsibility
of members and candidates who have an advisory relationship with those
individuals.
Sergei Gonchar is chairman of the
ACME Futures Exchange, which is launching a new bond futures contract. To
convince investors, traders, arbitrageurs, hedgers, and so on, to use its
contract, the exchange attempts to demonstrate that it has the best liquidity.
To do so, it enters into agreements with members in which they commit to a
substantial minimum trading volume on the new contract over a specific period
in exchange for substantial reductions of their regular commissions.
Comment: The formal liquidity of a
market is determined by the obligations set on market makers, but the actual
liquidity of a market is better estimated by the actual trading volume and
bid—ask spreads. Attempts to mislead participants about the actual liquidity of
the market constitute a violation of Standard Il(B). In this example, investors
have been intentionally misled to believe they chose the most liquid instrument
for some specific purpose, but they could eventually see the actual liquidity
of the contract significantly reduced after the term of the agreement expires.
If the ACME Futures Exchange fully discloses its agreement with members to
boost transactions over some initial launch period, it will not violate
Standard Il(B). ACME's intent is not to harm investors but, on the contrary, to
give them a better service. For that purpose, it may engage in a
liquidity-pumping strategy, but the strategy must be disclosed.
Example 5
(Pump and Dump Stratekv)
In an effort to pump up the price
of his holdings in Moosehead & Belfast Railroad Company, Steve Weinberg
logs on to several investor chat rooms on the Internet to start rumors that the
company is about to expand its rail network in anticipation of receiving a
large contract for shipping lumber.
Comment: Weinberg has violated
Standard Il(B) by disseminating false information about Moosehead & Belfast
with the intent to mislead market participants.
Example
6 (Information Manipulation)
Allen
King is a performance analyst for Torrey Investment Funds. King believes that
the portfolio manager for the firm's small- and microcap equity fund dislikes
him because the manager never offers him tickets to the local baseball team's
games but does offer tickets to other employees. To incite a potential
regulatory review of the manager, King creates user profiles on several online
forums under the portfolio manager's name and starts rumors about potential
mergers for several of the smaller companies in the portfolio. As the prices of
these companies' stocks increase, the portfolio manager sells the position,
which leads to an investigation by the regulator as King desired.
|
Comment: King has violated Standard Il(B) even though he did not personally profit
from the market's reaction to the rumor. In posting the false information, King
misleads others into believing the companies were likely to be acquired.
Although his intent was to create trouble for the portfolio manager, his
actions clearly manipulated the factual information that was available to the
market.
LESSON 3: STANDARD 111:
DUTIES TO CLIENTS
Loyalty, Prudence, and Care
B. Fair Dealing
c. Suitability
D. Performance Presentation
E. Preservation of Confidentiality
Standard Ill(A) Loyalty,
Prudence, and Care
The Standard
Members and candidates
have a duty of loyalty to their clients and must act with reasonable care and
exercise prudent judgment. Members and candidates must act for the benefit of
their clients and place their clients' interests before their employer's or their
own interests.
Guidance
•
Standard Ill(A) clarifies
that client interests are paramount. A member's or candidate's responsibility
to a client includes a duty of loyalty and a duty to exercise reasonable care.
Investment actions must be carried out for the sole benefit of the client and
in a manner the member or candidate believes, given the known facts and
circumstances, to be in the best interest of the client. Members and candidates
must exercise the same level of prudence, judgment, and care that they would
apply in the management and disposition of their own interests in similar
circumstances.
•
Prudence requires caution
and discretion. The exercise of prudence by investment professionals requires
that they act with the care, skill, and diligence that a reasonable person
acting in a like capacity and familiar with such matters would use. In the context
of managing a client's portfolio, prudence requires following the investment
parameters set forth by the client and balancing risk and return. Acting with
care requires members and candidates to act in a prudent and judicious manner
in avoiding harm to clients.
•
Standard Ill(A), however,
is not a substitute for a member's or candidate's legal or regulatory
obligations. As stated in Standard (A), members and candidates must abide by
the most strict requirements imposed on them by regulators or the Code and
Standards, including any legally imposed fiduciary duty.
•
Members and candidates must
also be aware of whether they have "custody" or effective control of
client assets. If so, a heightened level of responsibility arises. Members and
candidates are considered to have custody if they have any direct or indirect
access to client funds. Members and candidates must manage any pool of assets
in their control in accordance with the terms of the governing documents (such
as trust documents and investment management agreements), which are the primary
determinant of the manager's powers and duties.
Understanding the
Application of Loyalty, Prudence, and Care
•
|
Standard Ill(A) establishes a minimum benchmark for the duties of loyalty,
prudence, and care that are required of all members and candidates regardless
of whether a legal fiduciary duty applies. Although fiduciary duty often
encompasses the principles of loyalty, prudence, and care, Standard Ill(A) does
not render all members and candidates fiduciaries. The responsibilities of
members and candidates for fulfilling their obligations under this standard
depend greatly on the nature of their professional responsibilities and the
relationships they have with clients.
•
There is a large variety of
professional relationships that members and candidates have with their clients.
Standard Ill(A) requires them to fulfill the obligations outlined explicitly or
implicitly in the client agreements to the best of their abilities and with
loyalty, prudence, and care. Whether a member or candidate is structuring a new
securitization transaction, completing a credit rating analysis, or leading a
public company, he or she must work with prudence and care in delivering the
agreed-on services.
Identifying the Actual
Investment Client
•
The first step for members
and candidates in fulfilling their duty of loyalty to clients is to determine
the identity of the "client" to whom the duty of loyalty is owed. In
the context of an investment manager managing the personal assets of an
individual, the client is easily identified. When the manager is responsible
for the portfolios of pension plans or trusts, however, the client is not the
person or entity who hires the manager but, rather, the beneficiaries of the
plan or trust. The duty of loyalty is owed to the ultimate beneficiaries.
•
Members and candidates
managing a fund to an index or an expected mandate owe the duty of loyalty,
prudence, and care to invest in a manner consistent with the stated mandate.
The decisions of a fund's manager, although benefiting all fund investors, do
not have to be based on an individual investor's requirements and risk profile.
Client loyalty and care for those investing in the fund are the responsibility
of members and candidates who have an advisory relationship with those
individuals.
Developing the Client's
Portfolio
•
Professional investment
managers should ensure that the client's objectives and expectations for the
performance of the account are realistic and suitable to the client's
circumstances and that the risks involved are appropriate. In most
circumstances, recommended investment strategies should relate to the long-term
objectives and circumstances of the client.
•
When members and candidates
cannot avoid potential conflicts between their firm and clients' interests,
they must provide clear and factual disclosures of the circumstances to the
clients. 
Members and candidates must follow any
guidelines set by their clients for the management of their assets.
•
Investment decisions must
be judged in the context of the total portfolio rather than by individual
investment within the portfolio. The member's or candidate's duty is satisfied
with respect to a particular investment if the individual has thoroughly
considered the investment's place in the overall portfolio, the risk of loss
and opportunity for gains, tax implications, and the diversification,
liquidity, cash flow, and overall return requirements of the assets or the
portion of the assets for which the manager is responsible.
Soft Commission Policies
•
 |
An investment manager often has discretion over the selection of brokers
executing transactions. Conflicts may arise when an investment manager uses
client brokerage to purchase research services, a practice commonly called
"soft dollars" or "soft commissions." A member or candidate
who pays a higher brokerage commission than he or she would normally pay to
allow for the purchase of goods or services, without corresponding benefit to
the client, violates the duty of loyalty to the client. 
From time to time, a client will direct a manager to use the
client's brokerage to purchase goods or services for the client, a practice
that is commonly called "directed brokerage." Because brokerage
commission is an asset of the client and is used to benefit that client, not
the manager, such a practice does not violate any duty of loyalty. However, a
member or candidate is obligated to seek "best price" and "best
execution" and be assured by the client that the goods or services
purchased from the brokerage will benefit the account beneficiaries. In
addition, the member or candidate should disclose to the client that the client
may not be getting best execution from the directed brokerage.
•
"Best execution"
refers to a trading process that seeks to maximize the value of the client's
portfolio within the client's stated investment objectives and constraints.
Proxy Voting Policies
•
Part of a member's or
candidate's duty of loyalty includes voting proxies in an infomed and
responsible manner. Proxies have economic value to a client, and members and
candidates must ensure that they properly safeguard and maximize this value. 
An investment manager who fails to vote, casts
a vote without considering the impact of the question, or votes blindly with
management on nonroutine governance issues (e.g., a change in company
capitalization) may violate this standard. Voting of proxies is an integral
part of the management of investments.
•
A cost—benefit analysis may
show that voting all proxies may not benefit the client, so voting proxies may
not be necessary in all instances.
•
Members and candidates
should disclose to clients their proxy voting policies.
Recommended Procedures
for Compliance
Regular Account Information
Members and candidates
with control of client assets should:
•
Submit to each client, at
least quarterly, an itemized statement showing the funds and securities in the
custody or possession of the member or candidate plus all debits, credits, and
transactions that occurred during the period.
•
Disclose to the client
where the assets are to be maintained, as well as where or when they are moved.
•
Separate the client's
assets from any other party's assets, including the member's or candidate's own
assets.
Client Approval
•
If a member or candidate is
uncertain about the appropriate course of action with respect to a client, the
member or candidate should consider what he or she would expect or demand if
the member or candidate were the client.
•
If in doubt, a member or
candidate should disclose the questionable matter in writing to the client and
obtain client approval.
Firm Policies
Members and candidates
should address and encourage their firms to address the following topics when
drafting the statements or manuals containing their policies and procedures
regarding responsibilities to clients:
•
 |
Follow all applicable rules and laws: Members and candidates must follow all
legal requirements and applicable provisions of the Code and Standards.
•
Establish the investment
objectives Of the client: Make a reasonable inquiry into a client's investment
experience, risk and return objectives, and financial constraints prior to
making investment recommendations or taking investment actions. 
Consider all the information when taking
actions: When taking investment actions, members and candidates must consider
the appropriateness and suitability of the investment relative to (1) the
client's needs and circumstances, (2) the investment's basic characteristics,
and (3) the basic characteristics of the total portfolio. 
Diversify: Members and candidates should
diversify investments to reduce the risk of loss, unless diversification is not
consistent with plan guidelines or is contrary to the account objectives.
•
Carry out regular reviews:
Members and candidates should establish regular review schedules to ensure that
the investments held in the account adhere to the terms of the governing
documents.
•
Dealfairly with all clients
with respect to investment actions: Members and candidates must not favor some
clients over others and should establish policies for allocating trades and
disseminating investment recommendations.
•
Disclose conflicts of
interest: Members and candidates must disclose all actual and potential
conflicts of interest so that clients can evaluate those conflicts.
•
Disclose compensation
arrangements: Members and candidates should make their clients aware of all
forms of manager compensation.
•
Vote proxies: In most
cases, members and candidates should determine who is authorized to vote shares
and vote proxies in the best interests of the clients and ultimate
beneficiaries.
•
Maintain confidentiality:
Members and candidates must preserve the confidentiality of client information.
•
Seek best execution: Unless
directed by the client as ultimate beneficiary, members and candidates must
seek best execution for their clients. (Best execution is defined in the
preceding text.)
•
Place client interests
first: Members and candidates must serve the best interests of clients.
Application of the
Standard
Example 1 (Identifying the Client—Plan Participants)
First Country Bank serves as trustee for the Miller Company's
pension plan. Miller is the target of a hostile takeover attempt by Newton,
Inc. In attempting to ward off Newton, Miller's managers persuade Julian Wiley,
an investment manager at First Country Bank, to purchase Miller common stock in
the open market for the employee pension plan. Miller's officials indicate that
such action would be favorably received and would probably result in other
accounts being placed with the bank. Although Wiley believes the stock is
overvalued and would not ordinarily buy it, he purchases the stock to support
Miller's managers, to maintain Miller's good favor toward the bank, and to
realize additional new business. The heavy stock purchases cause Miller's
market price to rise to such a level that Newton retracts its takeover bid.
 |
Comment: Standard Ill(A) requires that a member or candidate, in evaluating a
takeover bid, act prudently and solely in the interests of plan participants
and beneficiaries. To meet this requirement, a member or candidate must
carefully evaluate the long-term prospects of the company against the
short-term prospects presented by the takeover offer and by the ability to
invest elsewhere. In this instance, Wiley, acting on behalf of his employer,
which was the trustee for a pension plan, clearly violated Standard Ill(A). He
used the pension plan to perpetuate existing management, perhaps to the
detriment of plan participants and the company's shareholders, and to benefit
himself. Wiley's responsibilities to the plan participants and beneficiaries
should have taken precedence over any ties of his bank to corporate managers
and over his self-interest. Wiley had a duty to examine the takeover offer on
its own merits and to make an independent decision. The guiding principle is
the appropriateness of the investment decision to the pension plan, not whether
the decision benefited Wiley or the company that hired him.
Example
2 (Client Commission Practices)
JNI, a successful investment counseling firm,
serves as investment manager for the pension plans of several large, regionally
based companies. Its trading activities generate a significant amount of
commission-related business. JM uses the brokerage and research services of
many firms, but most of its trading activity is handled through a large
brokerage company, Thompson, Inc., because the executives of the two firms have
a close friendship. Thompson's commission structure is high in comparison with
charges for similar brokerage services from other firms. JM considers
Thompson's research services and execution capabilities average. In exchange
for JNI directing its brokerage to Thompson, Thompson absorbs a number of JNI
overhead expenses, including those for rent.
Comment: JNI executives are breaching their
responsibilities by using client brokerage for services that do not benefit JNI
clients and by not obtaining best price and best execution for their clients.
Because JNI executives are not upholding their duty of loyalty, they are
violating Standard Ill(A).
Example 3 (Brokerage Arrangements)
Charlotte Everett, a struggling independent investment
adviser, serves as investment manager for the pension plans of several
companies. One of her brokers, Scott Company, is close to consummating
management agreements with prospective new clients whereby Everett would manage
the new client accounts and trade the accounts exclusively through Scott. One
of Everett's existing clients, Crayton Corporation, has directed Everett to place
securities transactions for Crayton's account exclusively through Scott. But to
induce Scott to exert efforts to send more new accounts to her, Everett also
directs transactions to Scott from other clients without their knowledge.
 |
Comment: Everett has an obligation at all times to seek best price and best
execution on all trades. Everett may direct new client trades exclusively
through Scott Company as long as Everett receives best price and execution on
the trades or receives a written statement from new clients that she is not to
seek best price and execution and that they are aware of the consequence for
their accounts. Everett may trade other accounts through Scott as a reward for
directing clients to Everett only if the accounts receive best price and
execution and the practice is disclosed to the accounts. Because Everett does
not disclose the directed trading, Everett has violated Standard Ill(A).
Example 4 (Brokerage Arrangements)
Emilie Rome is a trust officer for Paget Trust Company. Rome's
supervisor is responsible for reviewing Rome's trust account transactions and
her monthly reports of personal stock transactions. Rome has been using Nathan
Gray, a broker, almost exclusively for trust account brokerage transactions.
When Gray makes a market in stocks, he has been giving Rome a lower price for
personal purchases and a higher price for sales than he gives to Rome's trust
accounts and other investors.
Comment: Rome is violating her duty of loyalty to the bank's
trust accounts by using Gray for brokerage transactions simply because Gray
trades Rome's personal account on favorable terms. Rome is placing her own
interests before those of her clients.
Example
5 (Managing Family Accounts)
Adam
Dill recently joined New Investments Asset Managers. To assist Dill in building
a book of clients, both his father and brother opened new fee-paying accounts.
Dill followed all the firm's procedures in noting his relationships with these
clients and in developing their investment policy statements.
After
several years, the number of Dill's clients has grown, but he still manages the
original accounts of his family members. An IPO is coming to market that is a
suitable investment for many of his clients, including his brother. Dill does
not receive the amount of stock he requested, so to avoid any appearance of a
conflict of interest, he does not allocate any shares to his brother's account.
Comment: Dill has violated Standard Ill(A) because he is not
acting for the benefit of his brother's account as well as his other accounts.
The brother's account is a regular fee-paying account comparable to the
accounts of his other clients. By not allocating the shares proportionately
across all accounts for which he thought the IPO was suitable, Dill is
disadvantaging specific clients.
 |
Dill would have been correct in not allocating shares to his brother's account
if that account was being managed outside the normal fee structure of the firm.
|
Example 6
(Identifying the Client) Donna Hensley has been hired by a law firm to testify as an expert
witness. Although the testimony is intended to represent impartial advice,
she is concerned that her work may have negative consequences for the law
firm. If the law firm is Hensley's client, how does she ensure that her
testimony will not violate the required duty of loyalty, prudence, and care
to one's client? Comment:
In this situation, the law firm represents Hensley's employer and the aspect
of "Who is the client?" is not well defined. When acting as an
expert witness, Hensley is bound by the standard of independence and
objectivity in the same manner as an independent research analyst would be
bound. Hensley must not let the law firm influence the testimony she provides
in the legal proceedings. |
Example 7 (Client Loyalty)
After providing client account investment performance to the
external-facing departments but prior to it being finalized for release to
clients, Teresa Nguyen, an investment performance analyst, notices the
reporting system missed a trade. Correcting the omission resulted in a large
loss for a client that had previously placed the firm on "watch" for
potential termination owing to underperformance in prior periods. Nguyen knows
this news is unpleasant but informs the appropriate individuals that the report
needs to be updated before releasing it to the client.
Comment: Nguyen's actions align with the requirements of
Standard Ill(A). Even though the correction may to lead to the firm's
termination by the client, withholding information on errors would not be in
the best interest of the client.
|
Example 8
(Execution-Only Responsibilities) Baftija Sulejman
recently became a candidate in the CFA Program. He is a broker who executes
client-directed trades for several high-net-worth individuals. Sulejman does
not provide any investment advice and only executes the trading decisions
made by clients. He is concerned that the Code and Standards impose a
fiduciary duty on him in his dealing with clients and sends an e-mail to the
CFA Ethics Helpdesk (ethics@ cfainstitute.org) to seek guidance on this
issue. Comment: In this instance, Sulejman serves in an
execution-only capacity and his duty of loyalty, prudence, and care is
centered on the skill and diligence used when executing |
|
trades—namely,
by seeking best execution and making trades within the parameters set by the
clients (instructions on quantity, price, timing, etc.). Acting in the best
interests of the client dictates that trades are executed on the most favorable
terms that can be achieved for the client. Given this job function, the
requirements of the Code and Standards for loyalty, prudence, and care clearly
do not impose a fiduciary duty.
Standard Ill(B) Fair
Dealing
The Standard
Members and candidates
must deal fairly and objectively with all clients when providing investment
analysis, making investment recommendations, taking investment action, or
engaging in other professional activities.
Guidance
•
Standard Ill(B) requires
members and candidates to treat all clients fairly when disseminating
investment recommendations or making material changes to prior investment
recommendations, or when taking investment action with regard to general
purchases, new issues, or secondary offerings.
•
 |
The term "fairly" implies that the member or candidate must take care
not to discriminate against any clients when disseminating investment
recommendations or taking investment action. Standard Ill(B) does not state
"equally" because members and candidates could not possibly reach all
clients at exactly the same time. Further, each client has unique needs,
investment criteria, and investment objectives, so not all investment
opportunities are suitable for all clients. 
Members and candidates may provide more personal,
specialized, or in-depth service to clients who are willing to pay for premium
services through higher management fees or higher levels of brokerage. Members
and candidates may differentiate their services to clients, but different
levels of service must not disadvantage or negatively affect clients. In
addition, the different service levels should be disclosed to clients and
prospective clients and should be available to everyone (i.e., different seNice
levels should not be offered selectively).
Investment Recommendations
•
An investment
recommendation is any opinion expressed by a member or candidate in regard to
purchasing, selling, or holding a given security or other investment. The
opinion may be disseminated to customers or clients through an initial detailed
research report, through a brief update report, by addition to or deletion from
a list of recommended securities, or simply by oral communication. A
recommendation that is distributed to anyone outside the organization is
considered a communication for general distribution under Standard Ill(B).
•
Each member or candidate is
obligated to ensure that information is disseminated in such a manner that all
clients have a fair opportunity to act on every recommendation. Members and
candidates should encourage their firms to design an equitable system to
prevent selective or discriminatory disclosure and should inform clients about
what kind of communications they will receive. 
The duty to clients imposed by Standard Ill(B) may be more
critical when members or candidates change their recommendations than when they
make initial recommendations. Material changes in a member's or candidate's
prior investment recommendations because of subsequent research should be
communicated to all current clients; particular care should be taken that the
information reaches those clients who the member or candidate knows have acted
on or been affected by the earlier advice.
•
Clients who do not know
that the member or candidate has changed a recommendation and who, therefore,
place orders contrary to a current recommendation should be advised of the
changed recommendation before the order is accepted.
Investment Action
•
Members or candidates must
treat all clients fairly in light of their investment objectives and circumstances.
For 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 in a manner consistent with
the policies of the firm for allocating blocks of stock. If the issue is
oversubscribed, then the issue should be prorated to all subscribers. If the
issue is oversubscribed, members and candidates should forgo any sales to
themselves or their immediate families in order to free up additional shares
for clients. 
If the investment professional 's
family-member accounts are managed similarly to the accounts of other clients
of the firm, however, the familymember accounts should not be excluded from
buying such shares. 
Members and candidates must make every effort to treat all
individual and institutional clients in a fair and impartial manner.
•
 |
Members and candidates should disclose to clients and prospective clients the
documented allocation procedures they or their firms have in place and how the
procedures would affect the client or prospect. The disclosure should be clear
and complete so that the client can make an informed investment decision. Even
when complete disclosure is made, however, members and candidates must put client
interests ahead of their own. A member's or candidate's duty of fairness and
loyalty to clients can never be overridden by client consent to patently unfair
allocation procedures.
•
Treating clients fairly
also means that 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 (defined as securities of a
public offering that are trading at a premium in the secondary market whenever
such trading commences because of the great demand for the securities). Members
and candidates are prohibited from withholding such securities for their own
benefit and must not use such securities as a reward or incentive to gain
benefit.
Recommended Procedures for
Compliance
Develop Firm Policies
•
A member or candidate
should recommend appropriate procedures to management if none are in place.
•
A member or candidate
should make management aware of possible violations of fair-dealing practices
within the firm when they come to the attention of the member or candidate.
•
Although a member or
candidate need not communicate a recommendation to all customers, the selection
process by which customers receive information should be based on suitability
and known interest, not on any preferred or favored status.
A common practice to
assure fair dealing is to communicate recommendations simultaneously within the
firm and to customers. Members and candidates should consider the following
points when establishing fair-dealing compliance procedures:
Limit the number of people
involved.
Shorten the time frame between
decision and dissemination.
Publish guidelines for
pre-dissemination behavior.
Simultaneous dissemination.
Maintain a list of clients and
their holdings.
Develop and document trade
allocation procedures that ensure:
Fairness to advisory clients, both in priority
of execution of orders and in the allocation of the price obtained in execution
of block orders or trades. o Timeliness and efficiency in the execution of
orders.
Accuracy of the member's or candidate's records
as to trade orders and client account positions.
With these principles in
mind, members and candidates should develop or encourage their firm to develop
written allocation procedures, with particular attention to procedures for
block trades and new issues. Procedures to consider are as follows:
Requiring orders and modifications
or cancellations of orders to be documented and time stamped.
Processing and executing orders on
a first-in, first-out basis with consideration of bundling orders for efficiency
as appropriate for the asset class or the security. 
Developing a policy to address such issues as calculating
execution prices and "partial fills" when trades are grouped, or in a
block, for efficiency.
 |
Giving all client accounts participating in a block trade the same execution
price and charging the same commission.
When the full amount of the block
order is not executed, allocating partially executed orders among the
participating client accounts pro rata on the basis of order size while not
going below an established minimum lot size for some securities (e.g., bonds). 
When allocating trades for new issues,
obtaining advance indications of interest, allocating securities by client
(rather than portfolio manager), and providing a method for calculating
allocations.
Disclose 'frade
Allocation Procedures
Members and candidates should
disclose to clients and prospective clients how they select accounts to
participate in an order and how they determine the amount of securities each
account will buy or sell. Trade allocation procedures must be fair and
equitable, and disclosure of inequitable allocation methods does not relieve
the member or candidate of this obligation.
Establish Systematic Account
Review
Member and candidate supervisors
should review each account on a regular basis to ensure that no client or
customer is being given preferential treatment and that the investment actions
taken for each account are suitable for each account's objectives. 
Because investments should be based on individual needs and
circumstances, an investment manager may have good reasons for placing a given
security or other investment in one account while selling it from another
account and should fully document the reasons behind both sides of the
transaction.
Members and candidates should
encourage firms to establish review procedures, however, to detect whether
trading in one account is being used to benefit a favored client.
Disclose Levels of
Service
Members and candidates should
disclose to all clients whether the organization offers different levels of
service to clients for the same fee or different fees.
Different levels of service should
not be offered to clients selectively.
Application of the
Standard
Example
1 (Selective Disclosure)
Bradley Ames, a well-known and respected
analyst, follows the computer industry. In the course of his research, he finds
that a small, relatively unknown company whose shares are traded over the
counter has just signed significant contracts with some of the companies he
follows. After a considerable amount of investigation, Ames decides to write a
research report on the small company and recommend purchase of its shares.
While the report is being reviewed by the company for factual accuracy, Ames
schedules a luncheon with several of his best clients to discuss the company.
At the luncheon, he mentions the purchase recommendation scheduled to be sent
early the following week to all the firm's clients.
Comment:
Ames has violated Standard Ill(B) by disseminating the purchase recommendation
to the clients with whom he has lunch a week before the recommendation is sent
to all clients.
 |
Example 2 (Fair Dealing and IPO Distribution)
Dominic Morris works for a small
regional securities firm. His work consists of corporate finance activities and
investing for institutional clients. Arena, Ltd., is planning to go public. The
partners have secured rights to buy an arena football league franchise and are
planning to use the funds from the issue to complete the purchase. Because
arena football is the current rage, Morris believes he has a hot issue on his
hands. He has quietly negotiated some options for himself for helping convince
Arena to do the financing through his securities firm. When he seeks
expressions of interest, the institutional buyers oversubscribe the issue.
Morris, assuming that the institutions have the financial clout to drive the
stock up, then fills all orders (including his own) and decreases the
institutional blocks.
Comment: Morris has violated
Standard Ill(B) by not treating all customers fairly. He should not have taken
any shares himself and should have prorated the shares offered among all
clients. In addition, he should have disclosed to his firm and to his clients
that he received options as part of the deal [see Standard VI(A)—Disclosure of
Conflicts].
Example
3 (Fair Dealing and Transaction Allocation)
Eleanor
Preston, the chief investment officer of Porter Williams Investments (PWI), a
medium-size money management firm, has been trying to retain a client, Colby
Company. Management at Colby, which accounts for almost half of PWI's revenues,
recently told Preston that if the performance of its account did not improve,
it would find a new money manager. Shortly after this threat, Preston purchases
mortgage-backed securities (MBSs) for several accounts, including Colby's.
Preston is busy with a number of transactions that day, so she fails to
allocate the trades immediately or write up the trade tickets. A few days
later, when Preston is allocating trades, she notes that some of the MBSs have
significantly increased in price and some have dropped. Preston decides to
allocate the profitable trades to Colby and spread the losing trades among
several other PWI accounts.
Comment: Preston has violated Standard Ill(B)
by failing to deal fairly with her clients in taking these investment actions.
Preston should have allocated the trades prior to executing the orders, or she
should have had a systematic approach to allocating the trades, such as pro
rata, as soon as practical after they were executed. Among other things,
Preston must disclose to the client that the adviser may act as broker for,
receive commissions from, and have a potential conflict of interest regarding
both parties in agency cross-transactions. After the disclosure, she should
obtain from the client consent authorizing such transactions in advance.
Example 4 (Additional Services for Select Clients)
Jenpin Weng uses e-mail to issue a new recommendation to all his
clients. He then calls his three largest institutional clients to discuss the
recommendation in detail.
Comment: Weng has not violated Standard Ill(B) because he widely disseminated
the recommendation and provided the information to all his clients prior to
discussing it with a select few. Weng's largest clients received additional
personal service because they presumably pay higher fees or because they have a
large amount of assets under Weng's management. If Weng had discussed the
report with a select group of clients prior to distributing it to all his
clients, he would have violated Standard Ill(B).
Example 5 (Minimum Lot Allocations)
Lynn Hampton is a well-respected private wealth manager in her
community with a diversified client base. She determines that a new 10-year
bond being offered by Healthy Pharmaceuticals is appropriate for five of her
clients. Three clients request to purchase US$ 10,000 each, and the other two
request USS50,000 each. The minimum lot size is established at US$5,000, and
the issue is oversubscribed at the time of placement. Her firm's policy is that
odd-lot allocations, especially those below the minimum, should be avoided
because they may affect the liquidity of the security at the time of sale.
Hampton is informed she will receive only US$55,000 of the
offering for all accounts.
Hampton distributes the bond investments as follows: The three
accounts that requested US$ 10,000 are allocated USS5,000 each, and the two
accounts that requested US$50,000 are allocated US$20,000 each.
Comment: Hampton has not violated Standard Ill(B), even though
the distribution is not on a completely pro rata basis because of the required
minimum lot size. With the total allocation being significantly below the
amount requested, Hampton ensured that each client received at least the
minimum lot size of the issue. This approach allowed the clients to efficiently
sell the bond later if necessary.
Dominic Morris works for a small
regional securities firm. His work consists of corporate finance activities and
investing for institutional clients. Arena, Ltd., is planning to go public. The
partners have secured rights to buy an arena football league franchise and are
planning to use the funds from the issue to complete the purchase. Because
arena football is the current rage, Morris believes he has a hot issue on his
hands. He has quietly negotiated some options for himself for helping convince
Arena to do the financing through his securities firm. When he seeks
expressions of interest, the institutional buyers oversubscribe the issue.
Morris, assuming that the institutions have the financial clout to drive the
stock up, then fills all orders (including his own) and decreases the
institutional blocks.
Comment: Morris has violated
Standard Ill(B) by not treating all customers fairly. He should not have taken
any shares himself and should have prorated the shares offered among all
clients. In addition, he should have disclosed to his firm and to his clients
that he received options as part of the deal [see Standard VI(A)—Disclosure of
Conflicts].
Example
3 (Fair Dealing and Transaction Allocation)
Eleanor
Preston, the chief investment officer of Porter Williams Investments (PWI), a
medium-size money management firm, has been trying to retain a client, Colby
Company. Management at Colby, which accounts for almost half of PWI's revenues,
recently told Preston that if the performance of its account did not improve,
it would find a new money manager. Shortly after this threat, Preston purchases
mortgage-backed securities (MBSs) for several accounts, including Colby's.
Preston is busy with a number of transactions that day, so she fails to
allocate the trades immediately or write up the trade tickets. A few days
later, when Preston is allocating trades, she notes that some of the MBSs have
significantly increased in price and some have dropped. Preston decides to
allocate the profitable trades to Colby and spread the losing trades among
several other PWI accounts.
Comment: Preston has violated Standard Ill(B)
by failing to deal fairly with her clients in taking these investment actions.
Preston should have allocated the trades prior to executing the orders, or she
should have had a systematic approach to allocating the trades, such as pro
rata, as soon as practical after they were executed. Among other things,
Preston must disclose to the client that the adviser may act as broker for,
receive commissions from, and have a potential conflict of interest regarding
both parties in agency cross-transactions. After the disclosure, she should
obtain from the client consent authorizing such transactions in advance.
Example 4 (Additional Services for Select Clients)
Jenpin Weng uses e-mail to issue a new recommendation to all his
clients. He then calls his three largest institutional clients to discuss the
recommendation in detail.
|
Comment: Weng has not violated Standard Ill(B) because he widely disseminated
the recommendation and provided the information to all his clients prior to
discussing it with a select few. Weng's largest clients received additional
personal service because they presumably pay higher fees or because they have a
large amount of assets under Weng's management. If Weng had discussed the
report with a select group of clients prior to distributing it to all his
clients, he would have violated Standard Ill(B).
Example 5 (Minimum Lot Allocations)
Lynn Hampton is a well-respected private wealth manager in her
community with a diversified client base. She determines that a new 10-year
bond being offered by Healthy Pharmaceuticals is appropriate for five of her
clients. Three clients request to purchase US$ 10,000 each, and the other two
request USS50,000 each. The minimum lot size is established at US$5,000, and
the issue is oversubscribed at the time of placement. Her firm's policy is that
odd-lot allocations, especially those below the minimum, should be avoided
because they may affect the liquidity of the security at the time of sale.
Hampton is informed she will receive only US$55,000 of the
offering for all accounts.
Hampton distributes the bond investments as follows: The three
accounts that requested US$ 10,000 are allocated USS5,000 each, and the two
accounts that requested US$50,000 are allocated US$20,000 each.
Comment: Hampton has not violated Standard Ill(B), even though
the distribution is not on a completely pro rata basis because of the required
minimum lot size. With the total allocation being significantly below the
amount requested, Hampton ensured that each client received at least the
minimum lot size of the issue. This approach allowed the clients to efficiently
sell the bond later if necessary.
Example 6 (Excessive Trading)
Ling
Chan manages the accounts for many pension plans, including the plan of his
father's employer. Chan developed similar but not identical investment policies
for each client, so the investment portfolios are rarely the same. To minimize
the cost to his father's pension plan, he intentionally trades more frequently
in the accounts of other clients to ensure the required brokerage is incurred
to continue receiving free research for use by all the pensions.
Comment:
Chan is violating Standard Ill(B) because his trading actions are
disadvantaging his clients to enhance a relationship with a preferred client.
All clients are benefiting from the research being provided and should incur
their fair portion of the costs. This does not mean that additional trading should
occur if a client has not paid an equal portion of the commission; trading
should occur only as required by the strategy.
Example 7 (Fair Dealing among
Clients)
Paul Rove, performance analyst for Alpha-Beta Investment Management, is
describing to the firm's chief investment officer (CIO) two new reports he
would like to develop to assist the firm in meeting its obligations to treat
clients fairly. Because many of the firm's clients have similar investment
objectives and portfolios, Rove suggests a report detailing securities owned
across several clients and the percentage of the portfolio the security
represents. The second report would compare the monthly performance of
portfolios with similar strategies. The outliers within each report would be
submitted to the CIO for review.
Comment: As a performance analyst,
Rove likely has little direct contact with clients and thus has limited
opportunity to treat clients differently. The recommended reports comply with
Standard Ill(B) while helping the firm conduct after-the-fact reviews of how
effectively the firm's advisers are dealing with their clients' portfolios.
Reports that monitor the fair treatment of clients are an important oversight
tool to ensure that clients are treated fairly.
Standard Ill(C)
Suitability
The Standard
When Members and candidates
are in an advisory relationship with a client, they must:
Make a reasonable inquiry
into a client's or prospective client's investment experience, risk and return
objectives, and financial constraints prior to making any investment recommendation
or taking investment action and must reassess and update this information
regularly.
b. Determine that an
investment is suitable to the client's financial situation and consistent with
the client's written objectives, mandates, and constraints before making an
investment recommendation or taking investment action.
Judge the suitability of investments
in the context of the client's total portfolio.
2. When members and candidates are responsible
for managing a portfolio to a specific mandate, strategy, or style, they must
make only investment recommendations or take only investment actions that are
consistent with the stated objectives and constraints of the portfolio.
Guidance
Standard Ill(C) requires that
members and candidates who are in an investment advisory relationship with
clients consider carefully the needs, circumstances, and objectives of the
clients when determining the appropriateness and suitability of a given
investment or course of investment action.
In judging the suitability of a
potential investment, the member or candidate should review many aspects of the
client's knowledge, experience related to investing, and financial situation.
These aspects include, but are not limited to, the risk profile of the
investment as compared with the constraints of the client, the impact of the
investment on the diversity of the portfolio, and whether the client has the
means or net worth to assume the associated risk. The investment professional's
determination of suitability should reflect only the investment recommendations
or actions that a prudent person would be willing to undertake. Not every
investment opportunity will be suitable for every portfolio, regardless of the
potential return being offered. 
The responsibilities of members and candidates to gather
information and make a suitability analysis prior to making a recommendation or
taking investment action fall on those members and candidates who provide
investment advice in the course of an advisory relationship with a client.
Other members and candidates who are simply executing specific instructions for
retail clients when buying or selling securities, may not have the opportunity
to judge the suitability of a particular investment for the ultimate client.
Developing an Investment
Policy
When an advisory relationship exists, members and candidates must gather client
information at the inception of the relationship. Such information includes the
client's financial circumstances, personal data (such as age and occupation)
that are relevant to investment decisions, attitudes toward risk, and
objectives in investing. This information should be incorporated into a written
investment policy statement OPS) that addresses the client's risk tolerance,
return requirements, and all investment constraints (including time horizon,
liquidity needs, tax concerns, legal and regulatory factors, and unique
circumstances).
The IPS also should identify and
describe the roles and responsibilities of the parties to the advisory
relationship and investment process, as well as schedules for review and
evaluation of the IPS.
After formulating long-term capital
market expectations, members and candidates can assist in developing an
appropriate strategic asset allocation and investment program for the client,
whether these are presented in separate documents or incorporated in the IPS or
in appendices to the IPS.
Understanding the Client's
Risk Profile
The investment professional must
consider the possibilities of rapidly changing investment environments and
their likely impact on a client's holdings, both individual securities and the
collective portfolio.
The risk of many investment
strategies can and should be analyzed and quantified in advance.
Members and candidates should pay
careful attention to the leverage inherent in many synthetic investment
vehicles or products when considering them for use in a client's investment
program.
Ling
Chan manages the accounts for many pension plans, including the plan of his
father's employer. Chan developed similar but not identical investment policies
for each client, so the investment portfolios are rarely the same. To minimize
the cost to his father's pension plan, he intentionally trades more frequently
in the accounts of other clients to ensure the required brokerage is incurred
to continue receiving free research for use by all the pensions.
Comment:
Chan is violating Standard Ill(B) because his trading actions are
disadvantaging his clients to enhance a relationship with a preferred client.
All clients are benefiting from the research being provided and should incur
their fair portion of the costs. This does not mean that additional trading should
occur if a client has not paid an equal portion of the commission; trading
should occur only as required by the strategy.
Example 7 (Fair Dealing among
Clients)
|
Paul Rove, performance analyst for Alpha-Beta Investment Management, is
describing to the firm's chief investment officer (CIO) two new reports he
would like to develop to assist the firm in meeting its obligations to treat
clients fairly. Because many of the firm's clients have similar investment
objectives and portfolios, Rove suggests a report detailing securities owned
across several clients and the percentage of the portfolio the security
represents. The second report would compare the monthly performance of
portfolios with similar strategies. The outliers within each report would be
submitted to the CIO for review.
Comment: As a performance analyst,
Rove likely has little direct contact with clients and thus has limited
opportunity to treat clients differently. The recommended reports comply with
Standard Ill(B) while helping the firm conduct after-the-fact reviews of how
effectively the firm's advisers are dealing with their clients' portfolios.
Reports that monitor the fair treatment of clients are an important oversight
tool to ensure that clients are treated fairly.
Standard Ill(C)
Suitability
The Standard
When Members and candidates
are in an advisory relationship with a client, they must:
Make a reasonable inquiry
into a client's or prospective client's investment experience, risk and return
objectives, and financial constraints prior to making any investment recommendation
or taking investment action and must reassess and update this information
regularly.
b. Determine that an
investment is suitable to the client's financial situation and consistent with
the client's written objectives, mandates, and constraints before making an
investment recommendation or taking investment action.
Judge the suitability of investments
in the context of the client's total portfolio.
2. When members and candidates are responsible
for managing a portfolio to a specific mandate, strategy, or style, they must
make only investment recommendations or take only investment actions that are
consistent with the stated objectives and constraints of the portfolio.
Guidance
Standard Ill(C) requires that
members and candidates who are in an investment advisory relationship with
clients consider carefully the needs, circumstances, and objectives of the
clients when determining the appropriateness and suitability of a given
investment or course of investment action.
In judging the suitability of a
potential investment, the member or candidate should review many aspects of the
client's knowledge, experience related to investing, and financial situation.
These aspects include, but are not limited to, the risk profile of the
investment as compared with the constraints of the client, the impact of the
investment on the diversity of the portfolio, and whether the client has the
means or net worth to assume the associated risk. The investment professional's
determination of suitability should reflect only the investment recommendations
or actions that a prudent person would be willing to undertake. Not every
investment opportunity will be suitable for every portfolio, regardless of the
potential return being offered. The responsibilities of members and candidates to gather
information and make a suitability analysis prior to making a recommendation or
taking investment action fall on those members and candidates who provide
investment advice in the course of an advisory relationship with a client.
Other members and candidates who are simply executing specific instructions for
retail clients when buying or selling securities, may not have the opportunity
to judge the suitability of a particular investment for the ultimate client.
Developing an Investment
Policy
|
When an advisory relationship exists, members and candidates must gather client
information at the inception of the relationship. Such information includes the
client's financial circumstances, personal data (such as age and occupation)
that are relevant to investment decisions, attitudes toward risk, and
objectives in investing. This information should be incorporated into a written
investment policy statement OPS) that addresses the client's risk tolerance,
return requirements, and all investment constraints (including time horizon,
liquidity needs, tax concerns, legal and regulatory factors, and unique
circumstances).
The IPS also should identify and
describe the roles and responsibilities of the parties to the advisory
relationship and investment process, as well as schedules for review and
evaluation of the IPS.
After formulating long-term capital
market expectations, members and candidates can assist in developing an
appropriate strategic asset allocation and investment program for the client,
whether these are presented in separate documents or incorporated in the IPS or
in appendices to the IPS.
Understanding the Client's
Risk Profile
The investment professional must
consider the possibilities of rapidly changing investment environments and
their likely impact on a client's holdings, both individual securities and the
collective portfolio.
The risk of many investment
strategies can and should be analyzed and quantified in advance.
Members and candidates should pay
careful attention to the leverage inherent in many synthetic investment
vehicles or products when considering them for use in a client's investment
program.
Updating an Investment
Policy
Updating the IPS should be
repeated at least annually and also prior to material changes to any specific
investment recommendations or decisions on behalf of the client.
For an individual client,
important changes might include the number of dependents, personal tax status,
health, liquidity needs, risk tolerance, amount of wealth beyond that
represented in the portfolio, and extent to which compensation and other income
provide for current income needs. 
For an institutional client, such changes
might relate to the magnitude of unfunded liabilities in a pension fund, the
withdrawal privileges in an employee savings plan, or the distribution
requirements of a charitable foundation.
If clients withhold information
about their financial portfolios, the suitability analysis conducted by members
and candidates cannot be expected to be complete; it must be based on the
information provided.
The Need for
Diversification
The unique characteristics (or
risks) of an individual investment may become partially or entirely neutralized
when it is combined with other individual investments within a portfolio.
Therefore, a reasonable amount of diversification is thus the norm for many
portfolios.
|
An investment with high relative risk on its own may be a suitable investment
in the context of the entire portfolio or when the client's stated objectives
contemplate speculative or risky investments.
Members and candidates can be
responsible for assessing the suitability of an investment only on the basis of
the information and criteria actually provided by the client.
Addressing Unsolicited
Trading Requests
If an unsolicited request is
expected to have only a minimum impact on the entire portfolio because the size
of the requested trade is small or the trade would result in a limited change
to the portfolio's risk profile, the member or candidate should focus on
educating the investor on how the request deviates from the current policy statement,
and then she may follow her firm's policies regarding the necessary client
approval for executing unsuitable trades. At a minimum, the client should
acknowledge the discussion and accept the conditions that make the
recommendation unsuitable.
If an unsolicited request is
expected to have a material impact on the portfolio, the member or candidate
should use this opportunity to update the investment policy statement. Doing so
would allow the client to fully understand the potential effect of the requested
trade on his or her current goals or risk levels.
If the client declines to modify
her policy statements while insisting an unsolicited trade be made, the member
or candidate will need to evaluate the effectiveness of her services to the
client. The options available to the members or candidates will depend on the
services provided by their employer. Some firms may allow for the trade to be
executed in a new unmanaged account. If alternative options are not available,
members and candidates ultimately will need to determine whether they should
continue the advisory arrangement with the client.
Managing to an Index or
Mandate
Some members and
candidates do not manage money for individuals but are responsible for managing
a fund to an index or an expected mandate. The responsibility of these members
and candidates is to invest in a manner consistent with the stated mandate.
Recommended Procedures
for Compliance
Investment Policy
Statement
In formulating an
investment policy for the client, the member or candidate should take the
following into consideration:
Client 
type and nature of client, (2) the existence
of separate beneficiaries, and (3) approximate portion of total client assets
that the member or candidate is managing.
Investor objectives—Cl ) return
objectives (income, growth in principal, maintenance of purchasing power) and
(2) risk tolerance (suitability, stability of values). 
Investor 
liquidity needs; (2) expected cash flows
(patterns of additions and/or withdrawals); (3) investable funds (assets and
liabilities or other commitments); (4) time horizon; (5) tax considerations;
(6) regulatory and legal circumstances; (7) investor preferences, prohibitions,
circumstances, and unique needs; and (8) proxy voting responsibilities and
guidance. 
Performance measurement benchmarks.
Regular Updates
|
The investor's objectives and constraints should be maintained and reviewed
periodically to reflect any changes in the client's circumstances.
Suitability Test Policies
With the increase in regulatory
required suitability tests, members and candidates should encourage their firms
to develop related policies and procedures. The test procedures should require
the investment professional to look beyond the potential return of the
investment and include the following:
0 An analysis of the
impact on the portfolio's diversification.
o A comparison of the
investment risks with the client's assessed risk tolerance.
The fit of the investment with the required
investment strategy.
Application of the
Standard
Example 1 (Investment
Suitability—Risk Profile)
Caleb Smith, an investment
adviser, has two clients: Larry Robertson, 60 years old, and Gabriel Lanai, 40
years old. Both clients earn roughly the same salary, but Robertson has a much
higher risk tolerance because he has a large asset base. Robertson is willing
to invest part of his assets very aggressively; Lanai wants only to achieve a
steady rate of return with low volatility to pay for his children's education.
Smith recommends investing 20% of both portfolios in zero-yield, small-cap,
high-technology equity issues.
Comment: In Robertson's case, the
investment may be appropriate because of his financial circumstances and
aggressive investment position, but this investment is not suitable for Lanai.
Smith is violating Standard Ill(C) by applying Robertson's investment strategy
to Lanai because the two clients' financial circumstances and objectives
differ.
Example
2 (Investment Suitability—Entire Portfolio)
Jessica
McDowell, an investment adviser, suggests to Brian Crosby, a risk-averse
client, that covered call options be used in his equity portfolio. The purpose
would be to enhance Crosby's income and partially offset any untimely
depreciation in the portfolio's value should the stock market or other
circumstances affect his holdings unfavorably. McDowell educates Crosby about
all possible outcomes, including the risk of incurring an added tax liability
if a stock rises in price and is called away and, conversely, the risk of his
holdings losing protection on the downside if prices drop sharply.
Comment:
When determining suitability of an investment, the primary focus should be the
characteristics of the client's entire portfolio, not the characteristics of single
securities on an issue-by-issue basis. The basic characteristics of the entire
portfolio will largely determine whether investment recommendations are taking
client factors into account. Therefore, the most important aspects of a
particular investment are those that will affect the characteristics of the
total portfolio. In this case, McDowell properly considers the investment in
the context of the entire portfolio and thoroughly explains the investment to
the client.
Example
3 (Following an Investment Mandate)
|
Louis Perkowski manages a high-income mutual fund. He purchases zero-dividend
stock in a financial services company because he believes the stock is
undervalued and is in a potential growth industry, which makes it an attractive
investment.
Comment:
A zero-dividend stock does not seem to fit the mandate of the fund that
Perkowski is managing. Unless Perkowski's investment fits within the mandate or
is within the realm of allowable investments the fund has made clear in its
disclosures, Perkowski has violated Standard Ill(C).
Example 4
(Submanager and IPS Reviews)
Paul Ostrowski's investment
management business has grown significantly over the past couple of years, and
some clients want to diversify internationally. Ostrowski decides to find a submanager
to handle the expected international investments. Because this will be his
first subadviser, Ostrowski uses the CFA Institute model "request for
proposal" to design a questionnaire for his search. By his deadline, he
receives seven completed questionnaires from a variety of domestic and
international firms trying to gain his business. Ostrowski reviews all the
applications in detail and decides to select the firm that charges the lowest
fees because doing so will have the least impact on his firm's bottom line.
Comment: When selecting an external manager or
subadviser, Ostrowski needs to ensure that the new manager's services are
appropriate for his clients. This due diligence includes comparing the risk
profile of the clients with the investment strategy of the manager. In basing
the decision on the fee structure alone, Ostrowski may be violating Standard
Ill(C).
When clients ask to diversify into international products, it
is an appropriate time to review and update the clients' IPSs. Ostrowski's
review may determine that the risk of international investments modifies the
risk profiles of the clients or does not represent an appropriate investment.
See also Standard V(A)—Diligence and Reasonable Basis for
further discussion of the review process needed in selecting appropriate
submanagers.
Example 5 (Investment Suitability)
Andre Shrub owns and operates
Conduit, an investment advisory firm. Prior to opening Conduit, Shrub was an
account manager with Elite Investment, a hedge fund managed by his good friend
Adam Reed. To attract clients to a new Conduit fund, Shrub offers lower-than-normal
management fees. He can do so because the fund consists of two top-performing
funds managed by Reed. Given his personal friendship with Reed and the prior
performance record of these two funds, Shrub believes this new fund is a
winning combination for all parties. Clients quickly invest with Conduit to
gain access to the Elite funds. No one is turned away because Conduit is
seeking to expand its assets under management.
|
Comment: Shrub has violated Standard Ill(C) because the risk profile of the new
fund may not be suitable for every client. As an investment adviser, Shrub
needs to establish an investment policy statement for each client and recommend
only investments that match each client's risk and return profile in the IPS.
Shrub is required to act as more than a simple sales agent for Elite.
Although Shrub cannot disobey the
direct request of a client to purchase a specific security, he should fully
discuss the risks of a planned purchase and provide reasons why it might not be
suitable for a client. This requirement may lead members and candidates to
decline new customers if those customers' requested investment decisions are
significantly out of line with their stated requirements.
See also Standard V(A)—Diligence
and Reasonable Basis.
Standard Ill(D)
Performance Presentation
The Standard
When communicating
investment performance information, members and candidates must make reasonable
efforts to ensure that it is fair, accurate, and complete.
Guidance
Members and candidates must
provide credible performance information to clients and prospective clients and
to avoid misstating performance or misleading clients and prospective clients
about the investment performance of members or candidates or their firms.
Standard Ill(D) covers any practice
that would lead to misrepresentation of a member's or candidate's performance
record, whether the practice involves performance presentation or performance
measurement.
Members and candidates should not
state or imply that clients will obtain or benefit from a rate of return that
was generated in the past.
Research analysts promoting the
success or accuracy of their recommendations must ensure that their claims are
fair, accurate, and complete.
If the presentation is brief, the
member or candidate must make available to clients and prospects, on request,
the detailed information supporting that communication. Best practice dictates
that brief presentations include a reference to the limited nature of the
information provided.
Recommended Procedures for
Compliance
Apply the GIPS Standards
Compliance with the GIPS standards
is the best method to meet their obligations under Standard Ill(D).
Compliance without Applying
GIPS Standards
Members and candidates
can also meet their obligations under Standard Ill(D) by:
Considering the knowledge and
sophistication of the audience to whom a performance presentation is addressed.
Presenting the performance of the
weighted composite of similar portfolios rather than using a single
representative account.
Including terminated accounts as
part of performance history with a clear indication of when the accounts were
terminated.
|
Including disclosures that fully explain the performance results being reported
(for example, stating, when appropriate, that results are simulated when model
results are used, clearly indicating when the performance record is that of a
prior entity, or disclosing whether the performance is gross of fees, net of
fees, or after tax). 
Maintaining the data and records used to calculate the performance
being presented.
Application of the
Standard
Example
1 (Performance Calculation and Length of Time)
Kyle Taylor of Taylor Trust
Company, noting the performance of Taylor's common trust fund for the past two
years, states in a brochure sent to his potential clients, "You can expect
steady 25% annual compound growth of the value of your investments over the
year." Taylor Trust's common trust fund did increase at the rate of 25%
per year for the past year, which mirrored the increase of the entire market.
The fund has never averaged that growth for more than one year, however, and
the average rate of growth of all of its trust accounts for five years is 5%
per year.
Comment: Taylor's brochure is in
violation of Standard Ill(D). Taylor should have disclosed that the 25% growth
occurred in only one year. Additionally, Taylor did not include client accounts
other than those in the firm's common trust fund. A general claim of firm
performance should take into account the performance of all categories of
accounts. Finally, by stating that clients can expect a steady 25% annual
compound growth rate, Taylor is also violating Standard I(C)—Misrepresentation,
which prohibits assurances or guarantees regarding an investment.
Example 2 (Performance Calculation
and Asset Weighting)
Anna Judd, a senior partner of Alexander Capital
Management, circulates a performance report for the capital appreciation
accounts for the years 1988 through 2004. The firm claims compliance with the
GIPS standards. Returns are not calculated in accordance with the requirements
of the GIPS standards, however, because the composites are not asset weighted.
Comment: Judd is in violation of
Standard Ill(D). When claiming compliance with the GIPS standards, firms must
meet all of the requirements, make mandatory disclosures, and meet any other
requirements that apply to that firm's specific situation. Judd's violation is
not from any misuse of the data but from a false claim of GIPS compliance.
Example 3 (Performance Calculation
and Selected Accounts Only)
In a presentation prepared for prospective clients, William
Kilmer shows the rates of return realized over a five-year period by a
"composite" of his firm's discretionary accounts that have a
"balanced" objective. This composite, however, consisted of only a
few of the accounts that met the balanced criterion set by the firm, excluded
accounts under a certain asset level without disclosing the fact of their
exclusion, and included accounts that did not have the balanced mandate because
those accounts would boost the investment results. In addition, to achieve
better results, Kilmer manipulated the naiT0w range of accounts included in the
composite by changing the accounts that made up the composite over time.
Comment: Kilmer violated Standard Ill(D) by misrepresenting the facts in the
promotional material sent to prospective clients, distorting his firm's
performance record, and failing to include disclosures that would have
clarified the presentation.
Kyle Taylor of Taylor Trust
Company, noting the performance of Taylor's common trust fund for the past two
years, states in a brochure sent to his potential clients, "You can expect
steady 25% annual compound growth of the value of your investments over the
year." Taylor Trust's common trust fund did increase at the rate of 25%
per year for the past year, which mirrored the increase of the entire market.
The fund has never averaged that growth for more than one year, however, and
the average rate of growth of all of its trust accounts for five years is 5%
per year.
Comment: Taylor's brochure is in
violation of Standard Ill(D). Taylor should have disclosed that the 25% growth
occurred in only one year. Additionally, Taylor did not include client accounts
other than those in the firm's common trust fund. A general claim of firm
performance should take into account the performance of all categories of
accounts. Finally, by stating that clients can expect a steady 25% annual
compound growth rate, Taylor is also violating Standard I(C)—Misrepresentation,
which prohibits assurances or guarantees regarding an investment.
Example 2 (Performance Calculation
and Asset Weighting)
Anna Judd, a senior partner of Alexander Capital
Management, circulates a performance report for the capital appreciation
accounts for the years 1988 through 2004. The firm claims compliance with the
GIPS standards. Returns are not calculated in accordance with the requirements
of the GIPS standards, however, because the composites are not asset weighted.
Comment: Judd is in violation of
Standard Ill(D). When claiming compliance with the GIPS standards, firms must
meet all of the requirements, make mandatory disclosures, and meet any other
requirements that apply to that firm's specific situation. Judd's violation is
not from any misuse of the data but from a false claim of GIPS compliance.
Example 3 (Performance Calculation
and Selected Accounts Only)
In a presentation prepared for prospective clients, William
Kilmer shows the rates of return realized over a five-year period by a
"composite" of his firm's discretionary accounts that have a
"balanced" objective. This composite, however, consisted of only a
few of the accounts that met the balanced criterion set by the firm, excluded
accounts under a certain asset level without disclosing the fact of their
exclusion, and included accounts that did not have the balanced mandate because
those accounts would boost the investment results. In addition, to achieve
better results, Kilmer manipulated the naiT0w range of accounts included in the
composite by changing the accounts that made up the composite over time.
|
Comment: Kilmer violated Standard Ill(D) by misrepresenting the facts in the
promotional material sent to prospective clients, distorting his firm's
performance record, and failing to include disclosures that would have
clarified the presentation.
Example 4
(Performance Attribution Changes)
Art Purell is reviewing the quarterly performance attribution
reports for distribution to clients. Purell works for an investment management
firm with a bottom-up, fundamentals-driven investment process that seeks to add
value through stock selection. The attribution methodology currently compares
each stock with its sector. The attribution report indicates that the value
added this quarter came from asset allocation and that stock selection
contributed negatively to the calculated return. Through running several
different scenarios, Purell discovers that calculating attribution by comparing
each stock with its industry and then rolling the effect to the sector level
improves the appearance of the manager's stock selection activities. Because
the firm defines the attribution terms and the results better reflect the
stated strategy, Purell recommends that the client reports should use the
revised methodology.
Comment: Modifying the attribution methodology without proper
notifications to clients would fail to meet the requirements of Standard
Ill(D). Purrell's recommendation is being done solely for the interest of the
firm to improve its perceived ability to meet the stated investment strategy.
Such changes are unfair to clients and obscure the facts regarding the firm's
abilities. Had Purell believed the new methodology offered improvements to the
original model, then he would have needed to report the results of both
calculations to the client. The report should also include the reasons why the
new methodology is preferred, which would allow the client to make a meaningful
comparison to prior results and provide a basis for comparing future
attributions.
©
Example 5 (Performance Calculation
Methodology Disclosure)
While developing a new reporting
package for existing clients, Alisha Singh, a performance analyst, discovers
that her company's new system automatically calculates both timeweighted and
money-weighted returns. She asks the head of client services and retention
which value would be preferred given that the firm has various investment
strategies that include bonds, equities, securities without leverage, and
alternatives. Singh is told not to label the return value so that the firm may
show whichever value is greatest for the period.
Comment: Following these
instructions would lead to Singh violating Standard Ill(D). In reporting
inconsistent return values, Singh would not be providing complete information
to the firm's clients. Full information is provided when clients have
sufficient information to judge the performance generated by the firm.
Example 6 (Performance Calculation Methodology Disclosure)
Richmond Equity Investors manages a long—short equity fund in which clients can
trade once a week (on Fridays). For transparency reasons, a daily net asset
value of the fund is calculated by Richmond. The monthly fact sheets of the
fund report month-to-date and year-to-date performance. Richmond publishes the
performance based on the higher of the last trading day of the month
(typically, not the last business day) or the last business day of the month as
determined by Richmond. The fact sheet mentions only that the data are as of
the end of the month, without giving the exact date. Maggie Clark, the
investment performance analyst in charge of the calculations, is concerned
about the frequent changes and asks her supervisor whether they are
appropriate.
Comment: Clark's actions in questioning the changing
performance metric comply with Standard Ill(D). She has shown concern that
these changes are not presenting an accurate and complete picture of the
performance generated.
Standard Ill(E)
Preservation of Confidentiality
The Standard
Members and candidates
must keep information about current, former, and prospective clients
confidential unless:
The information concerns
illegal activities on the part of the client;
2.
Disclosure is required by
law; or
3.
The client or prospective
client permits disclosure of the information.
Guidance
Members and candidates must
preserve the confidentiality of information communicated to them by their
clients, prospective clients, and former clients. This standard is applicable
when (l) the member or candidate receives information because of his or her
special ability to conduct a portion of the client's business or personal
affairs and (2) the member or candidate receives information that arises from
or is relevant to that portion of the client's business that is the subject of
the special or confidential relationship.
If disclosure of the information
is required by law or the information concerns illegal activities by the
client, however, the member or candidate may have an obligation to report the
activities to the appropriate authorities.
Status of Client
This standard protects the
confidentiality of client information even if the person or entity is no longer
a client of the member or candidate. Therefore, members and candidates must
continue to maintain the confidentiality of client records even after the
client relationship has ended.
If a client or former client
expressly authorizes the member or candidate to disclose information, however,
the member or candidate may follow the terms of the authorization and provide
the information.
Compliance with Laws
As a general matter, members and
candidates must comply with applicable law. If applicable law requires
disclosure of client information in certain circumstances, members and
candidates must comply with the law. Similarly, if applicable law requires
members and candidates to maintain confidentiality, even if the information
concerns illegal activities on the part of the client, members and candidates
should not disclose such information.
When in doubt, members and
candidates should consult with their employer's compliance personnel or legal
counsel before disclosing confidential information about clients.
Electronic Information and
Security
Standard Ill(E) does not require
members or candidates to become experts in information security technology, but
they should have a thorough understanding of the policies of their employer.
Members and candidates should encourage their firm to conduct regular periodic
training on confidentiality procedures for all firm personnel, including
portfolio associates, receptionists, and other noninvestment staff who have
routine direct contact with clients and their records.
Professional Conduct
Investigations by CFA Institute
The requirements of Standard
Ill(E) are not intended to prevent members and candidates from cooperating with
an investigation by the CFA Institute Professional Conduct Program (PCP). When
permissible under applicable law, members and candidates shall consider the PCP
an extension of themselves when requested to provide information about a client
in support of a PCP investigation into their own conduct.
Recommended Procedures
for Compliance
The simplest, most
conservative, and most effective way to comply with Standard Ill(E) is to avoid
disclosing any information received from a client except to authorized fellow
employees who are also working for the client. In some instances, however, a
member or candidate may want to disclose information received from clients that
is outside the scope of the confidential relationship and does not involve
illegal activities. Before making such a disclosure, a member or candidate
should ask the following:
In what context was the
information disclosed? If disclosed in a discussion of work being performed for
the client, is the information relevant to the work?
Is the information background
material that, if disclosed, will enable the member or candidate to improve
service to the client?
Art Purell is reviewing the quarterly performance attribution
reports for distribution to clients. Purell works for an investment management
firm with a bottom-up, fundamentals-driven investment process that seeks to add
value through stock selection. The attribution methodology currently compares
each stock with its sector. The attribution report indicates that the value
added this quarter came from asset allocation and that stock selection
contributed negatively to the calculated return. Through running several
different scenarios, Purell discovers that calculating attribution by comparing
each stock with its industry and then rolling the effect to the sector level
improves the appearance of the manager's stock selection activities. Because
the firm defines the attribution terms and the results better reflect the
stated strategy, Purell recommends that the client reports should use the
revised methodology.
Comment: Modifying the attribution methodology without proper
notifications to clients would fail to meet the requirements of Standard
Ill(D). Purrell's recommendation is being done solely for the interest of the
firm to improve its perceived ability to meet the stated investment strategy.
Such changes are unfair to clients and obscure the facts regarding the firm's
abilities. Had Purell believed the new methodology offered improvements to the
original model, then he would have needed to report the results of both
calculations to the client. The report should also include the reasons why the
new methodology is preferred, which would allow the client to make a meaningful
comparison to prior results and provide a basis for comparing future
attributions.
©
Example 5 (Performance Calculation
Methodology Disclosure)
While developing a new reporting
package for existing clients, Alisha Singh, a performance analyst, discovers
that her company's new system automatically calculates both timeweighted and
money-weighted returns. She asks the head of client services and retention
which value would be preferred given that the firm has various investment
strategies that include bonds, equities, securities without leverage, and
alternatives. Singh is told not to label the return value so that the firm may
show whichever value is greatest for the period.
Comment: Following these
instructions would lead to Singh violating Standard Ill(D). In reporting
inconsistent return values, Singh would not be providing complete information
to the firm's clients. Full information is provided when clients have
sufficient information to judge the performance generated by the firm.
Example 6 (Performance Calculation Methodology Disclosure)
|
Richmond Equity Investors manages a long—short equity fund in which clients can
trade once a week (on Fridays). For transparency reasons, a daily net asset
value of the fund is calculated by Richmond. The monthly fact sheets of the
fund report month-to-date and year-to-date performance. Richmond publishes the
performance based on the higher of the last trading day of the month
(typically, not the last business day) or the last business day of the month as
determined by Richmond. The fact sheet mentions only that the data are as of
the end of the month, without giving the exact date. Maggie Clark, the
investment performance analyst in charge of the calculations, is concerned
about the frequent changes and asks her supervisor whether they are
appropriate.
Comment: Clark's actions in questioning the changing
performance metric comply with Standard Ill(D). She has shown concern that
these changes are not presenting an accurate and complete picture of the
performance generated.
Standard Ill(E)
Preservation of Confidentiality
The Standard
Members and candidates
must keep information about current, former, and prospective clients
confidential unless:
The information concerns
illegal activities on the part of the client;
2.
Disclosure is required by
law; or
3.
The client or prospective
client permits disclosure of the information.
Guidance
Members and candidates must
preserve the confidentiality of information communicated to them by their
clients, prospective clients, and former clients. This standard is applicable
when (l) the member or candidate receives information because of his or her
special ability to conduct a portion of the client's business or personal
affairs and (2) the member or candidate receives information that arises from
or is relevant to that portion of the client's business that is the subject of
the special or confidential relationship.
If disclosure of the information
is required by law or the information concerns illegal activities by the
client, however, the member or candidate may have an obligation to report the
activities to the appropriate authorities.
Status of Client
This standard protects the
confidentiality of client information even if the person or entity is no longer
a client of the member or candidate. Therefore, members and candidates must
continue to maintain the confidentiality of client records even after the
client relationship has ended.
If a client or former client
expressly authorizes the member or candidate to disclose information, however,
the member or candidate may follow the terms of the authorization and provide
the information.
Compliance with Laws
As a general matter, members and
candidates must comply with applicable law. If applicable law requires
disclosure of client information in certain circumstances, members and
candidates must comply with the law. Similarly, if applicable law requires
members and candidates to maintain confidentiality, even if the information
concerns illegal activities on the part of the client, members and candidates
should not disclose such information.
When in doubt, members and
candidates should consult with their employer's compliance personnel or legal
counsel before disclosing confidential information about clients.
Electronic Information and
Security
Standard Ill(E) does not require
members or candidates to become experts in information security technology, but
they should have a thorough understanding of the policies of their employer.
|
Members and candidates should encourage their firm to conduct regular periodic
training on confidentiality procedures for all firm personnel, including
portfolio associates, receptionists, and other noninvestment staff who have
routine direct contact with clients and their records.
Professional Conduct
Investigations by CFA Institute
The requirements of Standard
Ill(E) are not intended to prevent members and candidates from cooperating with
an investigation by the CFA Institute Professional Conduct Program (PCP). When
permissible under applicable law, members and candidates shall consider the PCP
an extension of themselves when requested to provide information about a client
in support of a PCP investigation into their own conduct.
Recommended Procedures
for Compliance
The simplest, most
conservative, and most effective way to comply with Standard Ill(E) is to avoid
disclosing any information received from a client except to authorized fellow
employees who are also working for the client. In some instances, however, a
member or candidate may want to disclose information received from clients that
is outside the scope of the confidential relationship and does not involve
illegal activities. Before making such a disclosure, a member or candidate
should ask the following:
In what context was the
information disclosed? If disclosed in a discussion of work being performed for
the client, is the information relevant to the work?
Is the information background
material that, if disclosed, will enable the member or candidate to improve
service to the client?
Communicating with Clients
Members and candidates should make
reasonable efforts to ensure that firmsupported communication methods and
compliance procedures follow practices designed for preventing accidental
distribution of confidential information.
Members and candidates should be
diligent in discussing with clients the appropriate methods for providing
confidential information. It is important to convey to clients that not all
firm-sponsored resources may be appropriate for such communications.
Application of the
Standard
Example 1 (Possessing Confidential Information)
Sarah Connor, a financial analyst employed by Johnson
Investment Counselors, Inc., provides investment advice to the trustees of City
Medical Center. The trustees have given her a number of internal reports
concerning City Medical's needs for physical plant renovation and expansion.
They have asked Connor to recommend investments that would generate capital
appreciation in endowment funds to meet projected capital expenditures. Connor
is approached by a local businessman, Thomas Kasey, who is considering a
substantial contribution either to City Medical Center or to another local
hospital. Kasey wants to find out the building plans of both institutions
before making a decision, but he does not want to speak to the trustees.
 |
Comment: The trustees gave Connor the internal reports so she could advise them
on how to manage their endowment funds. Because the information in the reports
is clearly both confidential and within the scope of the confidential
relationship, Standard Ill(E) requires that Connor refuse to divulge
information to Kasey.
|
Example 2
(Disclosing Confidential Information) Lynn Moody is an investment officer at the Lester Trust Company. She
has an advisory customer who has talked to her about giving approximately
USS50,000 to charity to reduce her income taxes. Moody is also treasurer of
the Home for Indigent Widows (HIW), which is planning its annual giving
campaign. HIW hopes to expand its list of prospects, particularly those
capable of substantial gifts. Moody recommends that HlW's vice president for
corporate gifts call on her customer and ask for a donation in the USS50,OOO
range. Comment: Even though the
attempt to help the Home for Indigent Widows was well intended, Moody
violated Standard Ill(E) by revealing confidential information about her
client. |
Example
3 (Disclosing Possible Illegal Activity)
 |
David Bradford manages money for a family-owned real estate development
corporation. He also manages the individual portfolios of several of the family
members and officers of the corporation, including the chief financial officer
(CFO). Based on the financial records of the corporation and some questionable
practices of the CFO that Bradford has observed, Bradford believes that the CFO
is embezzling money from the corporation and putting it into his personal
investment account.
Comment:
Bradford should check with his firm's compliance department or appropriate
legal counsel to determine whether applicable securities regulations require
reporting the CFO's financial records.
|
Example 4
(Accidental Disclosure of Confidential Information) Lynn Moody is an investment officer at the Lester Trust
Company (LTC). She has stewardship of a significant number of individually
managed taxable accounts. In addition to receiving quarterly written reports,
about a dozen high-net-worth individuals have indicated to Moody a willingness
to receive communications about overall economic and financial market
outlooks directly from her by way of a social media platform. Under the
direction of her firm's technology and compliance departments, she
established a new group page on an existing social media platform
specifically for her clients. In the instructions provided to clients, Moody
asked them to "join" the group so they may be granted access to the
posted content. The instructions also advised clients that all comments
posted would be available to the public and thus the platform was not an
appropriate method for communicating personal or confidential information. Six months
later, in early January, Moody posted LTC's year-end "Market
Outlook." The report outlined a new asset allocation strategy that the
firm is adding to its recommendations in the new year. Moody introduced the
publication with a note informing her clients that she would be discussing
the changes with them individually in their upcoming meetings. One of
Moody's clients responded directly on the group page that his family recently
experienced a major change in their financial profile. The client described
highly personal and confidential details of the event. Unfortunately, all
clients that were part of the group were also able to read the detailed
posting until Moody was able to have the comment removed. Comment: Moody has taken reasonable
steps for protecting the confidentiality of client information while using
the social media platform. She provided instructions clarifying that all
information posted to the site would be publicly viewable to all group
members and warned against using this method for communicating confidential
information. The accidental disclosure of confidential information by a
client is not under Moody's control. Her actions to remove the information
promptly once she became aware further align with Standard Ill(E). In understanding the potential sensitivity clients express
surrounding the confidentiality of personal information, this event
highlights a need for further training. Moody might advocate for additional
warnings or controls for clients when they consider using social media
platforms for two-way communications. |
LESSON 4: STANDARD IV:
DUTIES TO EMPLOYERS
Loyalty
B. Additional
Compensation Arrangements
c. Responsibilities of
Supervisors
Standard IV(A) Loyalty
The Standard
In matters related to
their employment, members and candidates must act for the benefit of their
employer and not deprive their employer of the advantage of their skills and
abilities, divulge confidential information, or otherwise cause harm to their
employer.
Guidance
Members and candidates should
protect the interests of their firm by refraining from any conduct that would
injure the firm, deprive it of profit, or deprive it of the member's or
candidate's skills and ability.
Members and candidates must always
place the interests of clients above the interests of their employer but should
also consider the effects of their conduct on the sustainability and integrity
of the employer firm.
In matters related to their
employment, members and candidates must comply with the policies and procedures
established by their employers that govern the employer—employee
relationship—to the extent that such policies and procedures do not conflict
with applicable laws, rules, or regulations or the Code and Standards.
 |
The standard does not require members and candidates to subordinate important
personal and family obligations to their work.
Employer Responsibilities
Employers must recognize the
duties and responsibilities that they owe to their employees if they expect to
have content and productive employees.
Members and candidates are
encouraged to provide their employer with a copy of the Code and Standards.
Employers are not obligated to
adhere to the Code and Standards. In expecting to retain competent employees
who are members and candidates, however, they should not develop conflicting
policies and procedures.
Independent Practice
Members and candidates must
abstain from independent competitive activity that could conflict with the
interests of their employer.
Members and candidates who plan to
engage in independent practice for compensation must notify their employer and
describe the types of services they will render to prospective independent
clients, the expected duration of the services, and the compensation for the
services.
Members and candidates should not
render services until they receive consent from their employer to all of the
terms of the arrangement.
"Practice" means any service that
the employer currently makes available for remuneration.
"Undertaking independent
practice" means engaging in competitive business, as opposed to making
preparations to begin such practice.
Leaving an Employer
When members and candidates are
planning to leave their current employer, they must continue to act in the
employer's best interest. They must not engage in any activities that would
conflict with this duty until their resignation becomes effective.
Activities that might constitute a
violation, especially in combination, include the following:
Misappropriation of trade secrets.
Misuse of confidential information.
Solicitation of the employer's
clients prior to cessation of employment.
Self-dealing (appropriating for
one's own property a business opportunity or information belonging to one's
employer).
Misappropriation of clients or client lists.
|
A departing employee is generally free to make arrangements or preparations to
go into a competitive business before terminating the relationship with his or
her employer as long as such preparations do not breach the employee's duty of
loyalty. 
A member or candidate who is contemplating seeking other
employment must not contact existing clients or potential clients prior to
leaving his or her employer for purposes of soliciting their business for the
new employer. Once notice is provided to the employer of the intent to resign,
the member or candidate must follow the employer's policies and procedures
related to notifying clients of his or her planned departure. In addition, the
member or candidate must not take records or files to a new employer without
the written permission of the previous employer. 
Once an employee has left the firm, the skills and experience
that an employee obtained while employed are not "confidential" or
"privileged" information. Similarly, simple knowledge of the names
and existence of former clients is generally not confidential information
unless deemed such by an agreement or by law.
Standard IV (A) does not prohibit
experience or knowledge gained at one employer from being used at another
employer. Firm records or work performed on behalf of the firm that is stored
in paper copy or electronically for the member's or candidate's convenience
while employed, however, should be erased or returned to the employer unless
the firm gives permission to keep those records after employment ends.
The standard does not prohibit
former employees from contacting clients of their previous firm as long as the
contact information does not come from the records of the former employer or
violate an applicable "noncompete agreement." Members and candidates
are free to use public information after departing to contact former clients
without violating Standard IV(A) as long as there is no specific agreement not
to do so.
Use of Social Media
Members and candidates should
understand and abide by all applicable firm policies and regulations as to the
acceptable use of social media platforms to interact with clients and
prospective clients.
Specific accounts and user
profiles of members and candidates may be created for solely professional
reasons, including firm-approved accounts for client engagements. Such
firm-approved business-related accounts would be considered part of the firm's
assets, thus requiring members and candidates to transfer or delete the
accounts as directed by their firm's policies and procedures.
Best practice for members and
candidates is to maintain separate accounts for their personal and professional
social media activities. Members and candidates should discuss with their
employers how profiles should be treated when a single account includes
personal connections and also is used to conduct aspects of their professional
activities.
Whistleblowing
Sometimes, circumstances
may arise (e.g., when an employer is engaged in illegal or unethical activity)
in which members and candidates must act contrary to their employer's interests
in order to comply with their duties to the market and clients. In such
instances, activities that would normally violate a member's or candidate's duty
to his or her employer (such as contradicting employer instructions, violating
certain policies and procedures, or preserving a record by copying employer
records) may be justified. However, such action would be permitted only if the
intent is clearly aimed at protecting clients or the integrity of the market,
not for personal gain.
Nature of Employment
Members and candidates must
determine whether they are employees or independent contractors in order to
determine the applicability of Standard IV(A). This issue will be decided
largely by the degree of control exercised by the employing entity over the
member or candidate. Factors determining control include whether the member's
or candidate's hours, work location, and other parameters of the job are set;
whether facilities are provided to the member or candidate; whether the
member's or candidate's expenses are reimbursed; whether the member or
candidate seeks work from other employers; and the number of clients or
employers the member or candidate works for.
 |
A member's or candidate's duties within an independent contractor relationship
are governed by the oral or written agreement between the member and the
client. Members and candidates should take care to define clearly the scope of
their responsibilities and the expectations of each client within the context
of each relationship. Once a member or candidate establishes a relationship
with a client, the member or candidate has a duty to abide by the terms of the
agreement.
Recommended Procedures for Compliance
Competition Policy
A member or candidate must
understand any restrictions placed by the employer on offering similar services
outside the firm while employed by the firm.
If a member's or candidate's
employer elects to have its employees sign a non-compete agreement as part of
the employment agreement, the member or candidate should ensure that the
details are clear and fully explained prior to signing the agreement.
Termination Policy
Members and candidates should
clearly understand the termination policies of their employer. Termination
policies should:
Establish clear procedures regarding the
resignation process, including addressing how the termination will be disclosed
to clients and staff and whether updates posted through social media platforms
will be allowed. o Outline the procedures for transferring ongoing research and
account management responsibilities.
Address agreements that allow departing
employees to remove specific client-related information upon resignation.
Incident-Reporting
Procedures
Members and candidates should be
aware of their firm's policies related to whistleblowing and encourage their
firm to adopt industry best practices in this area.
Employee Classification
Members and candidates should
understand their status within their employer firm.
Application of the
Standard
 |
Example 1 (Soliciting Former Clients)
Samuel Magee manages pension accounts for
Trust Assets, Inc., but has become frustrated with the working environment and
has been offered a position with Fiduciary Management. Before resigning from
Trust Assets, Magee asks four big accounts to leave that firm and open accounts
with Fiduciary. Magee also persuades several prospective clients to sign
agreements with Fiduciary Management. Magee had previously made presentations
to these prospects on behalf of Trust Assets.
Comment: Magee violated the
employee—employer principle requiring him to act solely for his employer's
benefit. Magee's duty is to Trust Assets as long as he is employed there. The
solicitation of Trust Assets' current clients and prospective clients is
unethical and violates Standard IV(A).
|
Example 2
(Addressing Rumors) Reuben Winston manages all-equity
portfolios at Target Asset Management (TAM), a large, established investment
counselor. Ten years previously, Philpott & Company, which manages a
family of global bond mutual funds, acquired TAM in a diversification move.
After the merger, the combined operations prospered in the fixed-income
business but the equity management business at TAM languished. Lately, a few
of the equity pension accounts that had been with TAM before the merger have terminated
their relationships with TAM. One day, Winston finds on his voice mail the
following message from a concerned client: "Hey! I just heard that
Philpott is close to announcing the sale of your firm's equity management
business to Rugged Life. What is going on?" Not being aware of any such
deal, Winston and his associates are stunned. Their internal inquiries are
met with denials from Philpott management, but the rumors persist. Feeling
left in the dark, Winston contemplates leading an employee buyout of TAM's
equity management business. Comment: An employee-led buyout of TAM's
equity asset management business would be consistent with Standard IV(A)
because it would rest on the permission of the employer and, ultimately, the
clients. In this case, however, in which employees suspect the senior
managers or principals are not truthful or forthcoming, Winston should
consult legal counsel to determine appropriate action.
|
Example 3 (Ownership of Completed Prior Work)
Emma Madeline, a recent college graduate and a candidate in
the CFA Program, spends her summer as an unpaid intern at Murdoch and Lowell.
The senior managers at Murdoch are attempting to bring the firm into compliance
with the GIPS standards, and Madeline is assigned to assist in its efforts. Two
months into her internship, Madeline applies for a job at McMillan &
Company, which has plans to become GIPS compliant. Madeline accepts the job
with McMillan. Before leaving Murdoch, she copies the firm's software that she
helped develop because she believes this software will assist her in her new
position.
Comment: Even though Madeline does not receive monetary
compensation for her services at Murdoch, she has used firm resources in
creating the software and is considered an employee because she receives
compensation and benefits in the form of work experience and knowledge. By
copying the software, Madeline violated Standard IV(A) because she
misappropriated Murdoch's property without permission.
Example 4 (Starting a New Firm)
Geraldine Allen currently works at a registered investment company as an equity
analyst. Without notice to her employer, she registers with government
authorities to start an investment company that will compete with her employer,
but she does not actively seek clients. Does registration of this competing
company with the appropriate regulatory authorities constitute a violation of
Standard IV(A)?
Comment:
Allen's preparation for the new business by registering with the regulatory
authorities does not conflict with the work for her employer if the
preparations have been done on Allen's own time outside the office and if Allen
will not be soliciting clients for the business or otherwise operating the new
company until she has left her current employer.
Example 5 (Competing with Current
Employer)
Several employees are planning to
depart their current employer within a few weeks and have been careful to not
engage in any activities that would conflict with their duty to their current
employer. They have just learned that one of their employer's clients has
undertaken a request for proposal (RFP) to review and possibly hire a new
investment consultant. The RFP has been sent to the employer and all of its
competitors. The group believes that the new entity to be formed would be
qualified to respond to the RFP and be eligible for the business. The RFP
submission period is likely to conclude before the employees' resignations are
effective. Is it permissible for the group of departing employees to respond to
the RFP for their anticipated new firm?
Comment: A group of employees
responding to an RFP that their employer is also responding to would lead to
direct competition between the employees and the employer. Such conduct
violates Standard IV(A) unless the group of employees receives permission from
their employer as well as the entity sending out the RFP.
Example 6 (Externally Compensated Assignments)
Alfonso Mota is a research analyst with Tyson Investments. He
works part time as a mayor for his hometown, a position for which he receives
compensation. Must Mota seek permission from Tyson to serve as mayor?
Comment: If Mota's mayoral duties are so extensive and
time-consuming that they might detract from his ability to fulfill his
responsibilities at Tyson, he should discuss his outside activities with his
employer and come to a mutual agreement regarding how to manage his personal
commitments with his responsibilities to his employer.
Example 7 (Soliciting Former Clients)
After leaving
her employer, Shawna McQuillen establishes her own money management business.
While with her former employer, she did not sign a noncompete agreement that
would have prevented her from soliciting former clients. Upon her departure,
she does not take any of her client lists or contact information and she clears
her personal computer of any employer records, including client contact
information. She obtains the phone numbers of her former clients through public
records and contacts them to solicit their business.
Comment: McQuillen is not in violation of Standard IV(A) because she has not
used information or records from her former employer and is not prevented by an
agreement with her former employer from soliciting her former clients.
Example 8 (Leaving an Employer)
Laura Webb just left her position as portfolio analyst at
Research Systems, Inc. (RSI). Her employment contract included a
nonsolicitation agreement that requires her to wait two years before soliciting
RSI clients for any investment-related services. Upon leaving, Webb was
informed that RSI would contact clients immediately about her departure and
introduce her replacement.
While working at RSI, Webb connected with clients, other
industry associates, and friends through her Linkedln network. Her business and
personal relationships were intermingled because she considered many of her
clients to be personal friends. Realizing that her Linkedln network would be a
valuable resource for new employment opportunities, she updated her profile
several days following her departure from RSL Linkedln automatically sent a
notification to Webb's entire network that her employment status had been
changed in her profile.
Comment: Prior to her departure, Webb should have discussed
any client information contained in her social media networks. By updating her
Linkedln profile after RSI notified clients and after her employment ended, she
has appropriately placed her employer's interests ahead of her own personal
interests. In addition, she has not violated the nonsolicitation agreement with
RSI, unless it prohibited any contact with clients during the two-year period.
©
Example 9
(Confidential Firm Information)
Sam Gupta is a research analyst at
Naram Investment Management (NIM). NIM uses a team-based research process to
develop recommendations on investment opportunities covered by the team
members. Gupta, like others, provides commentary for NIM's clients through the
company blog, which is posted weekly on the NIM passwordprotected website.
According to NIM's policy, every contribution to the website must be approved
by the company's compliance department before posting. Any opinions expressed
on the website are disclosed as representing the perspective of NIM.
Gupta also writes a personal blog
to share his experiences with friends and family. As with most blogs, Gupta's
personal blog is widely available to interested readers through various
Internet search engines. Occasionally, when he disagrees with the team-based
research opinions of NIM, Gupta uses his personal blog to express his own
opinions as a counterpoint to the commentary posted on the NIM website. Gupta
believes this provides his readers with a more complete perspective on these
investment opportunities.
Comment: Gupta is in violation of
Standard IV(A) for disclosing confidential firm information through his
personal blog. The recommendations on the firm's blog to clients are not freely
available across the internet, but his personal blog post indirectly provides
the firm's recommendations.
Additionally, by posting research commentary on his personal blog, Gupta is
using firm resources for his personal advantage. To comply with Standard IV(A),
members and candidates must receive consent from their employer prior to using
company resources.
|
Geraldine Allen currently works at a registered investment company as an equity
analyst. Without notice to her employer, she registers with government
authorities to start an investment company that will compete with her employer,
but she does not actively seek clients. Does registration of this competing
company with the appropriate regulatory authorities constitute a violation of
Standard IV(A)?
Comment:
Allen's preparation for the new business by registering with the regulatory
authorities does not conflict with the work for her employer if the
preparations have been done on Allen's own time outside the office and if Allen
will not be soliciting clients for the business or otherwise operating the new
company until she has left her current employer.
Example 5 (Competing with Current
Employer)
Several employees are planning to
depart their current employer within a few weeks and have been careful to not
engage in any activities that would conflict with their duty to their current
employer. They have just learned that one of their employer's clients has
undertaken a request for proposal (RFP) to review and possibly hire a new
investment consultant. The RFP has been sent to the employer and all of its
competitors. The group believes that the new entity to be formed would be
qualified to respond to the RFP and be eligible for the business. The RFP
submission period is likely to conclude before the employees' resignations are
effective. Is it permissible for the group of departing employees to respond to
the RFP for their anticipated new firm?
Comment: A group of employees
responding to an RFP that their employer is also responding to would lead to
direct competition between the employees and the employer. Such conduct
violates Standard IV(A) unless the group of employees receives permission from
their employer as well as the entity sending out the RFP.
Example 6 (Externally Compensated Assignments)
Alfonso Mota is a research analyst with Tyson Investments. He
works part time as a mayor for his hometown, a position for which he receives
compensation. Must Mota seek permission from Tyson to serve as mayor?
Comment: If Mota's mayoral duties are so extensive and
time-consuming that they might detract from his ability to fulfill his
responsibilities at Tyson, he should discuss his outside activities with his
employer and come to a mutual agreement regarding how to manage his personal
commitments with his responsibilities to his employer.
Example 7 (Soliciting Former Clients)
After leaving
her employer, Shawna McQuillen establishes her own money management business.
While with her former employer, she did not sign a noncompete agreement that
would have prevented her from soliciting former clients. Upon her departure,
she does not take any of her client lists or contact information and she clears
her personal computer of any employer records, including client contact
information. She obtains the phone numbers of her former clients through public
records and contacts them to solicit their business.
|
Comment: McQuillen is not in violation of Standard IV(A) because she has not
used information or records from her former employer and is not prevented by an
agreement with her former employer from soliciting her former clients.
Example 8 (Leaving an Employer)
Laura Webb just left her position as portfolio analyst at
Research Systems, Inc. (RSI). Her employment contract included a
nonsolicitation agreement that requires her to wait two years before soliciting
RSI clients for any investment-related services. Upon leaving, Webb was
informed that RSI would contact clients immediately about her departure and
introduce her replacement.
While working at RSI, Webb connected with clients, other
industry associates, and friends through her Linkedln network. Her business and
personal relationships were intermingled because she considered many of her
clients to be personal friends. Realizing that her Linkedln network would be a
valuable resource for new employment opportunities, she updated her profile
several days following her departure from RSL Linkedln automatically sent a
notification to Webb's entire network that her employment status had been
changed in her profile.
Comment: Prior to her departure, Webb should have discussed
any client information contained in her social media networks. By updating her
Linkedln profile after RSI notified clients and after her employment ended, she
has appropriately placed her employer's interests ahead of her own personal
interests. In addition, she has not violated the nonsolicitation agreement with
RSI, unless it prohibited any contact with clients during the two-year period.
©
Example 9
(Confidential Firm Information)
Sam Gupta is a research analyst at
Naram Investment Management (NIM). NIM uses a team-based research process to
develop recommendations on investment opportunities covered by the team
members. Gupta, like others, provides commentary for NIM's clients through the
company blog, which is posted weekly on the NIM passwordprotected website.
According to NIM's policy, every contribution to the website must be approved
by the company's compliance department before posting. Any opinions expressed
on the website are disclosed as representing the perspective of NIM.
Gupta also writes a personal blog
to share his experiences with friends and family. As with most blogs, Gupta's
personal blog is widely available to interested readers through various
Internet search engines. Occasionally, when he disagrees with the team-based
research opinions of NIM, Gupta uses his personal blog to express his own
opinions as a counterpoint to the commentary posted on the NIM website. Gupta
believes this provides his readers with a more complete perspective on these
investment opportunities.
Comment: Gupta is in violation of
Standard IV(A) for disclosing confidential firm information through his
personal blog. The recommendations on the firm's blog to clients are not freely
available across the internet, but his personal blog post indirectly provides
the firm's recommendations.
|
Additionally, by posting research commentary on his personal blog, Gupta is
using firm resources for his personal advantage. To comply with Standard IV(A),
members and candidates must receive consent from their employer prior to using
company resources.
Example
10 (Notification of Code and Standards)
Krista Smith is a relatively new assistant trader for the
fixed-income desk of a major investment bank. She is on a team responsible for
structuring collateralized debt obligations (CDOs) made up of securities in the
inventory of the trading desk. At a meeting of the team, senior executives
explain the opportunity to eventually separate the CDC) into various risk-rated
tranches to be sold to the clients of the firm. After the senior executives
leave the meeting, the head trader announces various responsibilities of each
member of the team and then says, "This is a good time to unload some of
the junk we have been stuck with for a while and disguise it with ratings and a
thick, unreadable prospectus, so don't be shy in putting this CDO together.
Just kidding." Smith is worried by this remark and asks some of her
colleagues what the head trader meant. They all respond that he was just
kidding but that there is some tnlth in the remark because the CDO is seen by
management as an opportunity to improve the quality of the securities in the
firm's inventory.
Concerned about the ethical environment of the workplace,
Smith decides to talk to her supervisor about her concerns and provides the
head trader with a copy of the Code and Standards. Smith discusses the principle
of placing the client above the interest of the firm and the possibility that
the development of the new CDC) will not adhere to this responsibility. The
head trader assures Smith that the appropriate analysis will be conducted when
determining the appropriate securities for collateral. Furthermore, the ratings
are assigned by an independent firm and the prospectus will include full and
factual disclosures. Smith is reassured by the meeting, but she also reviews
the company's procedures and requirements for reporting potential violations of
company policy and securities laws.
Comment: Smith's review of the company policies and procedures
for reporting violations allows her to be prepared to report through the
appropriate whistleblower process if she decides that the CDO development
process involves unethical actions by others. Smith's actions comply with the
Code and Standards principles of placing the client's interests first and being
loyal to her employer. In providing her supervisor with a copy of the Code and
Standards, Smith is highlighting the high level of ethical conduct she is
required to adhere to in her professional activities.
Standard IV(B) Additional
Compensation Arrangements
The Standard
Members and candidates
must not accept gifts, benefits, compensation, or consideration that competes
with or might reasonably be expected to create a conflict of interest with
their employer's interest unless they obtain written consent from all parties
involved.
Guidance
Members and candidates must obtain
permission from their employer before accepting compensation or other benefits
from third parties for the services rendered to the employer or for any
services that might create a conflict with their employer's interest.
0 Compensation and benefits include direct compensation by the client and any
indirect compensation or other benefits received from third parties. 
"Written consent" includes any form
of communication that can be documented (for example, communication via e-mail
that can be retrieved and documented).
Recommended Procedures
for Compliance
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
the compensation or benefits received from their employer.
The details of the report should
be confirmed by the party offering the additional compensation, including
performance incentives offered by clients.
This written report should state
the terms of any agreement under which a member or candidate will receive
additional compensation; "terms" include the nature of the
compensation, the approximate amount of compensation, and the duration of the
agreement.
Application of the
Standard
Example 1 (Notification of Client
Bonus Compensation)
Geoff Whitman, a portfolio analyst
for Adams Trust Company, manages the account of Carol Cochran, a client.
Whitman is paid a salary by his employer, and Cochran pays the trust company a
standard fee based on the market value of assets in her portfolio. Cochran
proposes to Whitman that "any year that my portfolio achieves at least a
15% return before taxes, you and your wife can fly to Monaco at my expense and
use my condominium during the third week of January." Whitman does not
inform his employer of the arrangement and vacations in Monaco the following
January as Cochran's guest.
Comment: Whitman violated Standard IV(B) by
failing to inform his employer in writing of this supplemental, contingent
compensation arrangement. The nature of the arrangement could have resulted in
partiality to Cochran's account, which could have detracted from Whitman's
performance with respect to other accounts he handles for Adams Trust. Whitman
must obtain the consent of his employer to accept such a supplemental benefit.
Example 2 (Notification of Outside Compensation)
Terry Jones sits on the board of directors of Exercise Unlimited, Inc. In
return for his services on the board, Jones receives unlimited membership
privileges for his family at all Exercise Unlimited facilities. Jones purchases
Exercise Unlimited stock for the client accounts for which it is appropriate.
Jones does not disclose this arrangement to his employer because he does not
receive monetary compensation for his services to the
Comment: Jones
has violated Standard IV(B) by failing to disclose to his employer benefits
received in exchange for his services on the board of directors. The
nonmonetary compensation may create a conflict of interest in the same manner
as being paid to serve as a director.
Example 3
(Prior Approval for Outside Compensation)
Jonathan Hollis is an analyst of
oil-and-gas companies for Specialty Investment Management. He is currently
recommending the purchase of ABC Oil Company shares and has published a long,
well-thought-out research report to substantiate his recommendation. Several
weeks after publishing the report, Hollis receives a call from the
investor-relations office of ABC Oil saying that Thomas Andrews, CEO of the
company, saw the report and really liked the analyst's grasp of the business
and his company. The investor-relations officer invites Hollis to visit ABC
Oil to discuss the industry further. ABC Oil offers to send a company plane
to pick Hollis up and arrange for his accommodations while visiting. Hollis,
after gaining the appropriate approvals, accepts the meeting with the CEO but
declines the offered travel arrangements.
Several weeks later, Andrews and Hollis meet to discuss the oil
business and Hollis's report. Following the meeting, Hollis joins Andrews and
the investment relations officer for dinner at an upscale restaurant near ABC
Oil's headquarters.
Upon returning to Specialty Investment Management, Hollis provides a
full review of the meeting to the director of research, including a
disclosure of the dinner attended.
Comment:
Hollis's actions did not violate Standard IV(B). Through gaining approval
before accepting the meeting and declining the offered travel arrangements,
Hollis sought to avoid any potential conflicts of interest between his
company and ABC Oil. Because the location of the dinner was not available
prior to arrival and Hollis notified his company of the dinner upon his
return, accepting the dinner should not impair his objectivity. By disclosing
the dinner, Hollis has enabled Specialty Investment
Management to assess whether it has any impact on
future reports and recommendations by Hollis related to ABC Oil.
Standard IV(C)
Responsibilities of Supervisors
The Standard
Members and candidates
must make reasonable efforts to ensure that anyone subject to their supervision
or authority complies with applicable laws, rules, regulations, and the Code
and Standards.
Guidance
Members and candidates must
promote actions by all employees under their supervision and authority to
comply with applicable laws, rules, regulations, and firm policies and the Code
and Standards.
A member's or candidate's
responsibilities under Standard IV(C) include instructing those subordinates to
whom supervision is delegated about methods to promote compliance, including
preventing and detecting violations of laws, rules, regulations, firm policies,
and the Code and Standards.
At a minimum, Standard IV(C) requires that members and candidates with supervisory
responsibility make reasonable efforts to prevent and detect violations by
ensuring the establishment of effective compliance systems. However, an
effective compliance system goes beyond enacting a code of ethics, establishing
policies and procedures to achieve compliance with the code and applicable law,
and reviewing employee actions to determine whether they are following the
rules. 
To be effective supervisors, members and candidates should implement
education and training programs on a recurring or regular basis for employees
under their supervision. Further, establishing incentives—monetary or
otherwise—for employees not only to meet business goals but also to reward
ethical behavior offers supervisors another way to assist employees in complying
with their legal and ethical obligations. 
A member or candidate with supervisory responsibility should
bring an inadequate compliance system to the attention of the firm's senior
managers and recommend corrective action. If the member or candidate clearly
cannot discharge supervisory responsibilities because of the absence of a
compliance system or because of an inadequate compliance system, the member or
candidate should decline in writing to accept super,'isory responsibility until
the firm adopts reasonable procedures to allow adequate exercise of supervisory
responsibility.
System for Supervision
Members and candidates with
super,'isory responsibility must understand what constitutes an adequate
compliance system for their firms and make reasonable efforts to see that
appropriate compliance procedures are established, documented, communicated to covered
personnel, and followed.
0
"Adequate" procedures are those designed to meet industry standards,
regulatory requirements, the requirements of the Code and Standards, and the
circumstances of the firm.
To be effective, compliance
procedures must be in place prior to the occurrence of a violation of the law
or the Code and Standards.
Once a supervisor learns that an
employee has violated or may have violated the law or the Code and Standards,
the supervisor must promptly initiate an assessment to determine the extent of
the wrongdoing. Relying on an employee's statements about the extent of the
violation or assurances that the wrongdoing will not reoccur is not enough.
Reporting the misconduct up the chain of command and warning the employee to
cease the activity are also not enough. Pending the outcome of the
investigation, a supervisor should take steps to ensure that the violation will
not be repeated, such as placing limits on the employee's activities or
increasing the monitoring of the employee's activities.
Krista Smith is a relatively new assistant trader for the
fixed-income desk of a major investment bank. She is on a team responsible for
structuring collateralized debt obligations (CDOs) made up of securities in the
inventory of the trading desk. At a meeting of the team, senior executives
explain the opportunity to eventually separate the CDC) into various risk-rated
tranches to be sold to the clients of the firm. After the senior executives
leave the meeting, the head trader announces various responsibilities of each
member of the team and then says, "This is a good time to unload some of
the junk we have been stuck with for a while and disguise it with ratings and a
thick, unreadable prospectus, so don't be shy in putting this CDO together.
Just kidding." Smith is worried by this remark and asks some of her
colleagues what the head trader meant. They all respond that he was just
kidding but that there is some tnlth in the remark because the CDO is seen by
management as an opportunity to improve the quality of the securities in the
firm's inventory.
Concerned about the ethical environment of the workplace,
Smith decides to talk to her supervisor about her concerns and provides the
head trader with a copy of the Code and Standards. Smith discusses the principle
of placing the client above the interest of the firm and the possibility that
the development of the new CDC) will not adhere to this responsibility. The
head trader assures Smith that the appropriate analysis will be conducted when
determining the appropriate securities for collateral. Furthermore, the ratings
are assigned by an independent firm and the prospectus will include full and
factual disclosures. Smith is reassured by the meeting, but she also reviews
the company's procedures and requirements for reporting potential violations of
company policy and securities laws.
Comment: Smith's review of the company policies and procedures
for reporting violations allows her to be prepared to report through the
appropriate whistleblower process if she decides that the CDO development
process involves unethical actions by others. Smith's actions comply with the
Code and Standards principles of placing the client's interests first and being
loyal to her employer. In providing her supervisor with a copy of the Code and
Standards, Smith is highlighting the high level of ethical conduct she is
required to adhere to in her professional activities.
Standard IV(B) Additional
Compensation Arrangements
The Standard
Members and candidates
must not accept gifts, benefits, compensation, or consideration that competes
with or might reasonably be expected to create a conflict of interest with
their employer's interest unless they obtain written consent from all parties
involved.
Guidance
Members and candidates must obtain
permission from their employer before accepting compensation or other benefits
from third parties for the services rendered to the employer or for any
services that might create a conflict with their employer's interest.
|
0 Compensation and benefits include direct compensation by the client and any
indirect compensation or other benefits received from third parties. "Written consent" includes any form
of communication that can be documented (for example, communication via e-mail
that can be retrieved and documented).
Recommended Procedures
for Compliance
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
the compensation or benefits received from their employer.
The details of the report should
be confirmed by the party offering the additional compensation, including
performance incentives offered by clients.
This written report should state
the terms of any agreement under which a member or candidate will receive
additional compensation; "terms" include the nature of the
compensation, the approximate amount of compensation, and the duration of the
agreement.
Application of the
Standard
Example 1 (Notification of Client
Bonus Compensation)
Geoff Whitman, a portfolio analyst
for Adams Trust Company, manages the account of Carol Cochran, a client.
Whitman is paid a salary by his employer, and Cochran pays the trust company a
standard fee based on the market value of assets in her portfolio. Cochran
proposes to Whitman that "any year that my portfolio achieves at least a
15% return before taxes, you and your wife can fly to Monaco at my expense and
use my condominium during the third week of January." Whitman does not
inform his employer of the arrangement and vacations in Monaco the following
January as Cochran's guest.
Comment: Whitman violated Standard IV(B) by
failing to inform his employer in writing of this supplemental, contingent
compensation arrangement. The nature of the arrangement could have resulted in
partiality to Cochran's account, which could have detracted from Whitman's
performance with respect to other accounts he handles for Adams Trust. Whitman
must obtain the consent of his employer to accept such a supplemental benefit.
Example 2 (Notification of Outside Compensation)
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Terry Jones sits on the board of directors of Exercise Unlimited, Inc. In
return for his services on the board, Jones receives unlimited membership
privileges for his family at all Exercise Unlimited facilities. Jones purchases
Exercise Unlimited stock for the client accounts for which it is appropriate.
Jones does not disclose this arrangement to his employer because he does not
receive monetary compensation for his services to the
Comment: Jones
has violated Standard IV(B) by failing to disclose to his employer benefits
received in exchange for his services on the board of directors. The
nonmonetary compensation may create a conflict of interest in the same manner
as being paid to serve as a director.
|
Example 3
(Prior Approval for Outside Compensation) Jonathan Hollis is an analyst of
oil-and-gas companies for Specialty Investment Management. He is currently
recommending the purchase of ABC Oil Company shares and has published a long,
well-thought-out research report to substantiate his recommendation. Several
weeks after publishing the report, Hollis receives a call from the
investor-relations office of ABC Oil saying that Thomas Andrews, CEO of the
company, saw the report and really liked the analyst's grasp of the business
and his company. The investor-relations officer invites Hollis to visit ABC
Oil to discuss the industry further. ABC Oil offers to send a company plane
to pick Hollis up and arrange for his accommodations while visiting. Hollis,
after gaining the appropriate approvals, accepts the meeting with the CEO but
declines the offered travel arrangements. Several weeks later, Andrews and Hollis meet to discuss the oil
business and Hollis's report. Following the meeting, Hollis joins Andrews and
the investment relations officer for dinner at an upscale restaurant near ABC
Oil's headquarters. Upon returning to Specialty Investment Management, Hollis provides a
full review of the meeting to the director of research, including a
disclosure of the dinner attended. Comment:
Hollis's actions did not violate Standard IV(B). Through gaining approval
before accepting the meeting and declining the offered travel arrangements,
Hollis sought to avoid any potential conflicts of interest between his
company and ABC Oil. Because the location of the dinner was not available
prior to arrival and Hollis notified his company of the dinner upon his
return, accepting the dinner should not impair his objectivity. By disclosing
the dinner, Hollis has enabled Specialty Investment Management to assess whether it has any impact on
future reports and recommendations by Hollis related to ABC Oil. |
Standard IV(C)
Responsibilities of Supervisors
The Standard
Members and candidates
must make reasonable efforts to ensure that anyone subject to their supervision
or authority complies with applicable laws, rules, regulations, and the Code
and Standards.
Guidance
Members and candidates must
promote actions by all employees under their supervision and authority to
comply with applicable laws, rules, regulations, and firm policies and the Code
and Standards.
A member's or candidate's
responsibilities under Standard IV(C) include instructing those subordinates to
whom supervision is delegated about methods to promote compliance, including
preventing and detecting violations of laws, rules, regulations, firm policies,
and the Code and Standards.
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At a minimum, Standard IV(C) requires that members and candidates with supervisory
responsibility make reasonable efforts to prevent and detect violations by
ensuring the establishment of effective compliance systems. However, an
effective compliance system goes beyond enacting a code of ethics, establishing
policies and procedures to achieve compliance with the code and applicable law,
and reviewing employee actions to determine whether they are following the
rules. To be effective supervisors, members and candidates should implement
education and training programs on a recurring or regular basis for employees
under their supervision. Further, establishing incentives—monetary or
otherwise—for employees not only to meet business goals but also to reward
ethical behavior offers supervisors another way to assist employees in complying
with their legal and ethical obligations. A member or candidate with supervisory responsibility should
bring an inadequate compliance system to the attention of the firm's senior
managers and recommend corrective action. If the member or candidate clearly
cannot discharge supervisory responsibilities because of the absence of a
compliance system or because of an inadequate compliance system, the member or
candidate should decline in writing to accept super,'isory responsibility until
the firm adopts reasonable procedures to allow adequate exercise of supervisory
responsibility.
System for Supervision
Members and candidates with
super,'isory responsibility must understand what constitutes an adequate
compliance system for their firms and make reasonable efforts to see that
appropriate compliance procedures are established, documented, communicated to covered
personnel, and followed.
0
"Adequate" procedures are those designed to meet industry standards,
regulatory requirements, the requirements of the Code and Standards, and the
circumstances of the firm.
To be effective, compliance
procedures must be in place prior to the occurrence of a violation of the law
or the Code and Standards.
Once a supervisor learns that an
employee has violated or may have violated the law or the Code and Standards,
the supervisor must promptly initiate an assessment to determine the extent of
the wrongdoing. Relying on an employee's statements about the extent of the
violation or assurances that the wrongdoing will not reoccur is not enough.
Reporting the misconduct up the chain of command and warning the employee to
cease the activity are also not enough. Pending the outcome of the
investigation, a supervisor should take steps to ensure that the violation will
not be repeated, such as placing limits on the employee's activities or
increasing the monitoring of the employee's activities.
Supervision Includes
Detection
Members and candidates with
supervisory responsibility must also make reasonable efforts to detect
violations of laws, rules, regulations, firm policies, and the Code and
Standards. If a member or candidate has adopted reasonable procedures and taken
steps to institute an effective compliance program, then the member or
candidate may not be in violation of Standard IV(C) if he or she does not
detect violations that occur despite these efforts. The fact that violations do
occur may indicate, however, that the compliance procedures are inadequate. 
In addition, in some cases, merely enacting such procedures may
not be sufficient to fulfill the duty required by Standard IV(C). A member or
candidate may be in violation of Standard IV(C) if he or she knows or should
know that the procedures designed to promote compliance, including detecting
and preventing violations, are not being followed.
Recommended Procedures for
Compliance
Codes of Ethics or
Compliance Procedures
Members and candidates are
encouraged to recommend that their employers adopt a code of ethics, and put in
place specific policies and procedures needed to ensure compliance with the
codes and with securities laws and regulations
Members and candidates should
encourage their employers to provide their codes of ethics to clients.
Adequate Compliance
Procedures
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Adequate compliance procedures should:
Be contained in a clearly written
and accessible manual that is tailored to the firm's operations.
Be drafted so that the procedures
are easy to understand.
Designate a compliance officer
whose authority and responsibility are clearly defined and who has the
necessary resources and authority to implement the firm's compliance
procedures.
Describe the hierarchy of
supervision and assign duties among supervisors.
Implement a system of checks and
balances.
Outline the scope of the
procedures.
Outline procedures to document the
monitoring and testing of compliance procedures.
Outline permissible conduct.
Delineate procedures for reporting
violations and sanctions.
Once a compliance program
is in place, a supervisor should:
Disseminate the contents of the
program to appropriate personnel.
Periodically update procedures to
ensure that the measures are adequate under the law.
Continually educate personnel
regarding the compliance procedures.
Issue periodic reminders of the
procedures to appropriate personnel.
Incorporate a professional conduct
evaluation as part of an employee's performance revlew.
Review the actions of employees to
ensure compliance and identify violators.
Take the necessary steps to
enforce the procedures once a violation has occurred.
Once a violation is
discovered, a supervisor should:
Respond promptly.
Conduct a thorough investigation
of the activities to determine the scope of the wrongdoing.
Increase supervision or place
appropriate limitations on the wrongdoer pending the outcome of the
investigation.
Review procedures for potential
changes necessary to prevent future violations from occurring.
Implementation of Compliance
Education and Training
Regular ethics and compliance
training, in conjunction with the adoption of a code of ethics, is critical to investment
firms seeking to establish a strong culture of integrity and to provide an
environment in which employees routinely engage in ethical conduct in
compliance with the law.
Establish an Appropriate
Incentive Structure
Supervisors and firms must look
closely at their incentive structure to determine whether the structure
encourages profits and returns at the expense of ethically appropriate conduct.
Only when compensation and incentives are firmly tied to client interests and
how outcomes are achieved, rather than how much is generated for the firm, will
employees work to achieve a culture of integrity.
Application of the
Standard
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Example 1 (Supervising Research Activities)
Jane Mattock, senior vice
president and head of the research department of H&V, Inc., a regional
brokerage firm, has decided to change her recommendation for Timber Products
from buy to sell. In line with H&V's procedures, she orally advises certain
other H&V executives of her proposed actions before the report is prepared
for publication. As a result of Mattock's conversation with Dieter Frampton,
one of the H&V executives accountable to Mattock, Frampton immediately
sells Timber's stock from his own account and from certain discretionary client
accounts. In addition, other personnel inform certain institutional customers
of the changed recommendation before it is printed and disseminated to all
H&V customers who have received previous 'Ember reports.
Comment: Mattock has violated
Standard IV(C) by failing to reasonably and adequately supervise the actions of
those accountable to her. She did not prevent or establish reasonable
procedures designed to prevent dissemination of or trading on the information by
those who knew of her changed recommendation. She must ensure that her firm has
procedures for reviewing or recording any trading in the stock of a corporation
that has been the subject of an unpublished change in recommendation. Adequate
procedures would have informed the subordinates of their duties and detected
sales by Frampton and selected customers.
Example 2 (Supervising 'frading Activities)
David Edwards, a trainee trader at Wheeler
& Company, a major national brokerage firm, assists a customer in paying
for the securities of Highland, Inc., by using anticipated profits from the
immediate sale of the same securities. Despite the fact
|
that
Highland is not on Wheeler's recommended list, a large volume of its stock is
traded through Wheeler in this manner. Roberta Ann Mason is a Wheeler vice
president responsible for supervising compliance with the securities laws in
the trading department. Part of her compensation from Wheeler is based on
commission revenues from the trading department. Although she notices the
increased trading activity, she does nothing to investigate or halt it. Comment: Mason's failure
to adequately review and investigate purchase orders in Highland stock
executed by Edwards and her failure to supervise the trainee's activities
violate Standard IV(C). Supervisors should be especially sensitive to actual
or potential conflicts between their own self-interests and their supervisory
responsibilities. |
Example 3 (Supervising Trading
Activities and Record Keeping)
|
Samantha Tabbing is senior vice president and portfolio manager for Crozet,
Inc., a registered investment advisory and registered broker/dealer firm. She
reports to Charles Henry, the president of Crozet. Crozet serves as the
investment adviser and principal underwriter for ABC and XYZ public mutual
funds. The two funds' prospectuses allow Crozet to trade financial futures for
the funds for the limited purpose of hedging against market risks. Henry,
extremely impressed by Tabbing's performance in the past two years, directs
Tabbing to act as portfolio manager for the funds. For the benefit of its
employees, Crozet has also organized the Crozet Employee Profit-Sharing Plan
(CEPSP), a defined contribution retirement plan. Henry assigns Tabbing to
manage 20% of the assets of CEPSP. Tabbing's investment objective for her
portion of CEPSP's assets is aggressive growth. Unbeknownst to Henry, Tabbing
frequently places S&P 500 Index purchase and sale orders for the funds and
the CEPSP without providing the futures commission merchants (FCMs) who take
the orders with any prior or simultaneous designation of the account for which
the trade has been placed. Frequently, neither Tabbing nor anyone else at
Crozet completes an internal trade ticket to record the time an order was
placed or the specific account for which the order was intended. FCMs often
designate a specific account only after the trade, when Tabbing provides such
designation. Crozet has no written operating procedures or compliance manual
concerning its futures trading, and its compliance department does not review
such trading. After observing the market's movement, Tabbing assigns to CEPSP
the S&P 500 positions with more favorable execution prices and assigns
positions with less favorable execution prices to the funds.
Comment: Henry violated Standard
IV(C) by failing to adequately supervise Tabbing with respect to her S&P
500 trading. Henry further violated Standard IV(C) by failing to establish
record-keeping and reporting procedures to prevent or detect Tabbing's
violations. Henry must make a reasonable effort to determine that adequate
compliance procedures covering all employee trading activity are established,
documented, communicated, and followed.
Example 4 (Supervising Research
Activities)
Mary Burdette was recently hired
by Fundamental Investment Management (FIM) as a junior auto industry analyst.
Burdette is expected to expand the social media presence of the firm because
she is active with various networks, including Facebook, Linkedln, and Twitter.
Although Burdette's supervisor, Joe Graf, has never used social media, he
encourages Burdette to explore opportunities to increase FIM's online presence
and ability to share content, communicate, and broadcast information to
clients. In response to Graf's encouragement, Burdette is working on a proposal
detailing the advantages of getting FIM onto Twitter in addition to launching a
company Facebook page.
As part of her auto industry
research for FIM, Burdette is completing a report on the financial impact of
Sun Drive Auto Ltd.'s new solar technology for compact automobiles. This
research report will be her first for FIM, and she believes Sun Drive's technology
could revolutionize the auto industry. In her excitement, Burdette sends a
quick tweet to FIM Twitter followers summarizing her "buy"
recommendation for Sun Drive Auto stock.
Comment: Graf has violated Standard IV(C) by
failing to reasonably supervise Burdette with respect to the contents of her
tweet. He did not establish reasonable procedures to prevent the unauthorized
dissemination of company research through social media networks. Graf must make
sure all employees receive regular training about FIM's policies and
procedures, including the appropriate business use of personal social media
networks.
See Standard Ill(B) for additional
guidance.
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Example 5 (Supervising Research Activities)
Chen Wang leads the research
department at YYRA Retirement Planning Specialists.
Chen supervises a team of 10
analysts in a fast-paced and understaffed organization. He is responsible for
coordinating the firm's approved process to review all reports before they are
provided to the portfolio management team for use in rebalancing client
portfolios.
One of Chen's direct reports,
Huang Mei, covers the banking industry. Chen must submit the latest updates to
the portfolio management team tomorrow morning. Huang has yet to submit her
research report on ZYX Bank because she is uncomfortable providing a "buy"
or "sell" opinion of ZYX on the basis of the completed analysis.
Pressed for time and concerned that Chen will reject a "hold"
recommendation, she researches various websites and blogs on the banking sector
for whatever she can find on ZYX. One independent blogger provides a new
interpretation of the recently reported data Huang has analyzed and concludes
with a strong "sell" recommendation for ZYX. She is impressed by the
originality and resourcefulness of this blogger's report.
Very late in the evening, Huang
submits her report and "sell" recommendation to Chen without any
reference to the independent blogger's report. Given the late time of the
submission and the competence of Huang's prior work, Chen compiles this report
with the recommendations from each of the other analysts and meets with the
portfolio managers to discuss implementation.
92
©
Comment: Chen has violated Standard IV(C) by
neglecting to reasonably and adequately follow the firm's approved review
process for Huang's research report. The delayed submission and the quality of
prior work do not remove Chen's requirement to uphold the designated review
process. A member or candidate with supervisory responsibility must make
reasonable efforts to see that appropriate procedures are established,
documented, communicated to covered personnel, and followed.
LESSON 5: STANDARD V:
INVESTMENT ANALYSIS, RECOMMENDATIONS AND ACTIONS
Diligence and Reasonable
Basis
B. Communication with
Clients and Prospective Clients
c. Record Retention
Standard V(A) Diligence
and Reasonable Basis
The Standard
Members and candidates
must:
Exercise diligence,
independence, and thoroughness in analyzing investments, making investment
recommendations, and taking investment actions.
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2. Have a reasonable and adequate
basis, supported by appropriate research and investigation, for any investment
analysis, recommendation, or action.
Guidance
The requirements for issuing
conclusions based on research will vary in relation to the member's or
candidate's role in the investment decision-making process, but the member or
candidate must make reasonable efforts to cover all pertinent issues when
arriving at a recommendation.
Members and candidates enhance
transparency by providing or offering to provide supporting information to
clients when recommending a purchase or sale or when changing a recommendation.
Defining Diligence and
Reasonable Basis
As with determining the
suitability of an investment for the client, the necessary level of research
and analysis will differ with the product, security, or service being offered.
The following list provides some, but definitely not all, examples of
attributes to consider while forming the basis for a recommendation:
Global, regional, and country macroeconomic
conditions. 
A company's operating and financial history.
The industry's and sector's
current conditions and the stage of the business cycle.
A mutual fund's fee structure and management
history.
The output and potential limitations of
quantitative models. o The quality of the assets included in a securitization.
The appropriateness of selected
peer-group comparisons.
The steps taken in developing a
diligent and reasonable recommendation should minimize unexpected downside
events.
Using Secondary or
Third-Party Research
If members and candidates rely on
secondary or third-party research, they must make reasonable and diligent
efforts to determine whether such research is sound. 
Secondary research is defined as research
conducted by someone else in the member's or candidate's firm.
Third-party research is research
conducted by entities outside the member's or candidate's firm, such as a
brokerage firm, bank, or research firm. 
Members and candidates should make reasonable inquiries into the
source and accuracy of all data used in completing their investment analysis
and recommendations.
Criteria that a member or
candidate can use in forming an opinion on whether research is sound include
the following: 
Assumptions used.
Rigor of the analysis performed. o
Date/timeliness of the research.
Evaluation of the objectivity and independence
of the recommendations. 
A member or candidate may rely on others in his or her firm to
determine whether secondary or third-party research is sound and use the
information in good faith unless the member or candidate has reason to question
its validity or the processes and procedures used by those responsible for the
research.
A member or candidate should
verify that the firm has a policy about the timely and consistent review of
approved research providers to ensure that the quality of the research
continues to meet the necessary standards. If such a policy is not in place at
the firm, the member or candidate should encourage the development and adoption
of a formal review practice.
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Using
Quantitatively Oriented Research
Members and candidates must have
an understanding of the parameters used in models and quantitative research
that are incorporated into their investment recommendations. Although they are
not required to become experts in every technical aspect of the models, they
must understand the assumptions and limitations inherent in any model and how
the results were used in the decision-making process. 
Members and candidates should make reasonable
efforts to test the output of investment models and other pre-programmed
analytical tools they use. Such validation should occur before incorporating
the process into their methods, models, or analyses.
Although not every model can test
for every factor or outcome, members and candidates should ensure that their
analyses incorporate a broad range of assumptions sufficient to capture the
underlying characteristics of investments. The omission from the analysis of
potentially negative outcomes or of levels of risk outside the norm may
misrepresent the true economic value of an investment. The possible scenarios
for analysis should include factors that are likely to have a substantial
influence on the investment value and may include extremely positive and
negative scenarios.
Developing Quantitatively
Oriented Techniques
Members and candidates involved in
the development and oversight of quantitatively oriented models, methods, and
algorithms must understand the technical aspects of the products they provide
to clients. A thorough testing of the model and resulting analysis should be
completed prior to product distribution. 
In reviewing the computer models or the resulting output, members
and candidates need to pay particular attention to the assumptions used in the
analysis and the rigor of the analysis to ensure that the model incorporates a
wide range of possible input expectations, including negative market events.
Selecting External Advisers
and Subadvisers
Members and candidates must review
managers as diligently as they review individual funds and securities.
Members and candidates who are
directly involved with the use of external advisers need to ensure that their
firms have standardized criteria for reviewing these selected external advisers
and managers. Such criteria would include, but would not be limited to, the
following:
Reviewing the adviser's established code of
ethics.
Understanding the adviser's compliance and
internal control procedures. o Assessing the quality of the published return
information.
Reviewing the adviser's investment
process and adherence to its stated strategy.
Group Research and
Decision Making
In some instances, a member or candidate will not agree
with the view of the group. If, however, the member or candidate believes that
the consensus opinion has a reasonable and adequate basis and is independent
and objective, the member or candidate need not decline to be identified with
the report. If the member or candidate is confident in the process, the member
or candidate does not need to dissociate from the report even if it does not
reflect his or her opinion.
Recommended Procedures for
Compliance
Members and candidates
should encourage their firms to consider the following policies and procedures
to support the principles of Standard V (A):
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Establish a policy requiring that research reports, credit ratings, and
investment recommendations have a basis that can be substantiated as reasonable
and adequate.
Develop detailed, written guidance
for analysts (research, investment, or credit), supervisory analysts, and
review committees that establishes the due diligence procedures for judging
whether a particular recommendation has a reasonable and adequate basis.
Develop measurable criteria for
assessing the quality of research, the reasonableness and adequacy of the basis
for any recommendation or rating, and the accuracy of recommendations over
time.
Develop detailed, written guidance
that establishes minimum levels of scenario testing of all computer-based
models used in developing, rating, and evaluating financial instruments.
Develop measurable criteria for
assessing outside providers, including the quality of information being
provided, the reasonableness and adequacy of the provider's collection
practices, and the accuracy of the information over time. 
Adopt a standardized set of criteria for evaluating the adequacy of
external advisers.
Application of the
Standard
Example
1 (Sufficient Due Diligence)
Helen
Hawke manages the corporate finance department of Sarkozi Securities, Ltd. The
firm is anticipating that the government will soon close a tax loophole that
currently allows oil-and-gas exploration companies to pass on drilling expenses
to holders of a certain class of shares. Because market demand for this
tax-advantaged class of stock is
currently high, Sarkozi convinces several
companies to undertake new equity financings at once, before the loophole
closes. Time is of the essence, but Sarkozi lacks sufficient resources to
conduct adequate research on all the prospective issuing companies. Hawke
decides to estimate the IPO prices on the basis of the relative size of each
company and to justify the pricing later when her staff has time.
Comment: Sarkozi should have taken on only the
work that it could adequately handle. By categorizing the issuers by general
size, Hawke has bypassed researching all the other relevant aspects that should
be considered when pricing new issues and thus has not performed sufficient due
diligence. Such an omission can result in investors purchasing shares at prices
that have no actual basis. Hawke has violated Standard V(A).
Example 2 (Sufficient Scenario Testing)
Babu Dhaliwal works for Heinrich Brokerage in the corporate
finance group. He has just persuaded Feggans Resources, Ltd., to allow his firm
to do a secondary equity financing at Feggans Resources' current stock price.
Because the stock has been trading at higher multiples than similar companies
with equivalent production, Dhaliwal presses the Feggans Resources managers to
project what would be the maximum production they could achieve in an optimal
scenario. Based on these numbers, he is able to justify the price his firm will
be asking for the secondary issue. During a sales pitch to the brokers,
Dhaliwal then uses these numbers as the base-case production levels that
Feggans Resources will achieve.
|
Comment: When presenting information to the brokers, Dhaliwal should have given
a range of production scenarios and the probability of Feggans Resources
achieving each level. By giving the maximum production level as the likely
level of production, he has misrepresented the chances of achieving that
production level and seriously misled the brokers. Dhaliwal has violated
Standard V(A).
Example 3 (Reliance on Third-Party Research)
Gary McDermott runs a two-person investment management firm.
McDermott's firm subscribes to a service from a large investment research firm
that provides research reports. McDermott's firm makes investment
recommendations on the basis of these reports.
Comment: Members and candidates can rely on third-party
research but must make reasonable and diligent efforts to determine that such
research is sound. If McDermott undertakes due diligence efforts on a regular
basis to ensure that the research produced by the large firm is objective and
reasonably based, McDermott can rely on that research when making investment
recommendations to clients.
Example
4 (Quantitative Model Diligence)
Barry
Cannon is the lead quantitative analyst at CityCenter Hedge Fund. He is
responsible for the development, maintenance, and enhancement of the
proprietary models the fund uses to manage its investors' assets. Cannon reads
several high-level mathematical publications and blogs to stay informed of
current developments. One
©
blog, run by Expert CFA, presents some
intriguing research that may benefit one of CityCenter's current models. Cannon
is under pressure from firm executives to improve the model's predictive
abilities, and he incorporates the factors discussed in the online research.
The updated output recommends several new investments to the fund's portfolio
managers.
Comment: Cannon has violated Standard V(A) by
failing to have a reasonable basis for the new recommendations made to the
portfolio managers. He needed to diligently research the effect of
incorporating the new factors before offering the output recommendations.
Cannon may use the blog for ideas, but it is his responsibility to determine
the effect on the firm's proprietary models.
See Standard VII(B) regarding the violation by
"Expert CFA" in the use of the CFA designation.
Example 5 (Selecting a Service Provider)
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Ellen Smith is a performance analyst at Artic Global Advisors, a firm that
manages global equity mandates for institutional clients. She was asked by her
supervisor to review five new performance attribution systems and recommend one
that would more appropriately explain the firm's investment strategy to
clients. On the list was a system she recalled learning about when visiting an
exhibitor booth at a recent conference. The system is highly quantitative and
something of a "black box" in how it calculates the attribution
values. Smith recommended this option without researching the others because
the sheer complexity of the process was sure to impress the clients.
Comment: Smith's actions do not demonstrate a sufficient level
of diligence in reviewing this product to make a recommendation for selecting
the service. Besides not reviewing or considering the other four potential
systems, she did not determine whether the "black box" attribution
process aligns with the investment practices of the firm, including its
investments in different countries and currencies. Smith must review and
understand the process of any software or system before recommending its use as
the firm's attribution system.
Example 6 (Subadviser Selection)
Craig Jackson is
working for Adams Partners, Inc., and has been assigned to select a hedge fund
subadviser to improve the diversification of the firm's large fund-of-funds
product. The allocation must be in place before the start of the next quarter.
Jackson uses a consultant database to find a list of suitable firms that claim
compliance with the GIPS standards. He calls more than 20 firms on the list to
confirm their potential interest and to determine their most recent quarterly
and annual total return values. Because of the short turnaround, Jackson
recommends the firm with the greatest total return values for selection.
Comment: By considering only performance and GIPS compliance,
Jackson has not conducted sufficient review of potential firms to satisfy the
requirements of Standard V(A). A thorough investigation of the firms and their
operations should be conducted to ensure that their addition would increase the
diversity of clients' portfolios and that they are suitable for the
fund-of-funds product.
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Example 7
(Manager Selection) Timothy Green
works for Peach Asset Management, where he creates proprietary models that
analyze data from the firm request for proposal questionnaires to identify
managers for possible inclusion in the firm's fund-of-funds investment
platform. Various criteria must be met to be accepted to the platform.
Because of the number of respondents to the questionnaires, Green uses only
the data submitted to make a recommendation for adding a new manager. Comment: By
failing to conduct any additional outside review of the information to verify
what was submitted through the request for proposal, Green has likely not
satisfied the requirements of Standard V(A). The amount of information
requested from outside managers varies among firms. Although the requested
information may be comprehensive, Green should ensure sufficient effort is
undertaken to verify the submitted information before recommending a firm for
inclusion. This requires that he go beyond the information provided by the
manager on the request for proposal questionnaire and may include interviews
with interested managers, reviews of regulatory filings, and discussions with
the managers' custodian or auditor. |
Example
8 (Technical Model Requirements)
Jérôme
Dupont works for the credit research group of XYZ Asset Management, where he is
in charge of developing and updating credit risk models. In order to perform
accurately, his models need to be regularly updated with the latest market
data.
Dupont
does not interact with or manage money for any of the firm's clients. He is in
contact with the firm's U.S. corporate bond fund manager, John Smith, who has
only very superficial knowledge of the model and who from time to time asks
very basic questions regarding the output recommendations. Smith does not
consult Dupont with respect to finalizing his clients' investment strategies.
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Dupont's recently assigned objective is to develop a new emerging market
corporate credit risk model. The firm is planning to expand into emerging
credit, and the development of such a model is a critical step in this process.
Because Smith seems to follow the model's recommendations without much concern
for its quality as he develops his clients' investment strategies, Dupont decides
to focus his time on the development of the new emerging market model and
neglects to update the U .S. model.
After
several months without regular updates, Dupont's diagnostic statistics start to
show alarming signs with respect to the quality of the U.S. credit model.
Instead of conducting the long and complicated data update, Dupont introduces
new codes into his model with some limited new data as a quick "fix."
He thinks this change will address the issue without needing to complete the
full data update, so he continues working on the new emerging market model.
Several months following the quick
'fix," another set of diagnostic statistics reveals nonsensical results
and Dupont realizes that his earlier change contained an error. He quickly
corrects the error and alerts Smith. Smith realizes that some of the prior
trades he performed were due to enoneous model results. Smith rebalances the
portfolio to remove the securities purchased on the basis of the questionable
results without reporting the issue to anyone else.
Comment: Smith violated Standard V(A) because exercising
"diligence, independence, and thoroughness in analyzing investments,
making investment recommendations, and taking investment actions" means
that members and candidates must understand the technical aspects of the
products they provide to clients. Smith does not understand the model he is
relying on to manage money. Members and candidates should also make reasonable
inquiries into the source and accuracy of all data used in completing their
investment analysis and recommendations.
Dupont violated Standard V(A) even if he does not trade
securities or make investment decisions. Dupont's models give investment
recommendations, and Dupont is accountable for the quality of those
recommendations. Members and candidates should make reasonable efforts to test
the output of pre-programmed analytical tools they use. Such validation should
occur before incorporating the tools into their decision-making process.
See also Standard V(B)—Communication with Clients and
Prospective Clients.
Standard V(B)
Communication with Clients and Prospective Clients
The Standard
Members and candidates
must:
Disclose to clients and
prospective clients the basic format and general principles of the investment
processes they use to analyze investments, select securities, and construct
portfolios, and must promptly disclose any changes that might materially affect
those processes.
2.
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Disclose to clients and prospective clients significant limitations and risks
associated with the investment process.
3.
Use reasonable judgment in
identifying which factors are important to their investment analyses,
recommendations, or actions, and include those factors in communications with
clients and prospective clients.
4.
Distinguish between fact
and opinion in the presentation of investment analyses and recommendations.
Guidance
Members and candidates should
communicate in a recommendation the factors that were instrumental in making
the investment recommendation. A critical part of this requirement is to
distinguish clearly between opinions and facts.
Follow-up communication of
significant changes in the risk characteristics of a security or asset strategy
is required.
Providing regular updates to any
changes in the risk characteristics is recommended.
Informing Clients of the
Investment Process
Members and candidates must
adequately describe to clients and prospective clients the manner in which they
conduct the investment decision-making process. Such disclosure should address
factors that have positive and negative influences on the recommendations,
including significant risks and limitations of the investment process used.
The member or candidate must keep
clients and other interested parties informed on an ongoing basis about changes
to the investment process, especially newly identified significant risks and
limitations.
Members and candidates should
inform the clients about the specialization or diversification expertise
provided by the external adviser(s).
Different Forms of
Communication
Members and candidates using any
social media service to communicate business information must be diligent in
their efforts to avoid unintended problems because these services may not be
available to all clients. When providing information to clients through new
technologies, members and candidates should take reasonable steps to ensure
that such delivery would treat all clients fairly and, if necessary, be
considered publicly disseminated.
If recommendations are contained
in capsule form (such as a recommended stock list), members and candidates
should notify clients that additional information and analyses are available
from the producer of the report.
Identifying Risks and
Limitations
Members and candidates must
outline to clients and prospective clients significant risks and limitations of
the analysis contained in their investment products or recommendations.
The appropriateness of risk
disclosure should be assessed on the basis of what was known at the time the
investment action was taken (often called an ex ante basis). Members and
candidates must disclose significant risks known to them at the time of the
disclosure. Members and candidates cannot be expected to disclose risks they
are unaware of at the time recommendations or investment actions are made. 
Having no knowledge of a risk or limitation that
subsequently triggers a loss may reveal a deficiency in the diligence and
reasonable basis of the research of the member or candidate but may not reveal
a breach of Standard V(B).
Report Presentation
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A report writer who has done adequate investigation may emphasize certain
areas, touch briefly on others, and omit certain aspects deemed unimportant.
Investment advice based on
quantitative research and analysis must be supported by readily available reference
material and should be applied in a manner consistent with previously applied
methodology. If changes in methodology are made, they should be highlighted.
Distinction between Facts
and Opinions in Reports
Violations often occur when
reports fail to separate the past from the future by not indicating that
earnings estimates, changes in the outlook for dividends, or future market
price information are opinions subject to future circumstances.
In the case of complex
quantitative analyses, members and candidates must clearly separate fact from
statistical conjecture and should identify the known limitations of an
analysis.
Members and candidates should
explicitly discuss with clients and prospective clients the assumptions used in
the investment models and processes to generate the analysis. Caution should be
used in promoting the perceived accuracy of any model or process to clients
because the ultimate output is merely an estimate of future results and not a certainty.
Recommended Procedures
for Compliance
Members and candidates should
encourage their firms to have a rigorous methodology for reviewing research
that is created for publication and dissemination to clients.
To assist in the after-the-fact
review of a report, the member or candidate must maintain records indicating
the nature of the research and should, if asked, be able to supply additional
information to the client (or any user of the report) covering factors not
included in the report.
Application of the
Standard
Example 1 (Sufficient Disclosure of Investment System)
Sarah
Williamson, director of marketing for Country Technicians, Inc., is convinced
that she has found the perfect formula for increasing Country Technicians'
income and diversifying its product base. Williamson plans to build on Country
Technicians' reputation as a leading money manager by marketing an exclusive
and expensive investment advice letter to high-net-worth individuals. One hitch
in the plan is the complexity of Country Technicians' investment system—a
combination of technical trading rules (based on historical price and volume
fluctuations) and portfolio construction rules designed to minimize risk. To
simplify the newsletter, she decides to include only each week's top five
"buy" and "sell" recommendations and to leave out details
of the valuation models and the portfolio structuring scheme.
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Comment: Williamson's plans for the newsletter violate Standard V(B).
Williamson need not describe the investment system in detail in order to
implement the advice effectively, but she must inform clients of Country
Technicians' basic process and logic. Without understanding the basis for a
recommendation, clients cannot possibly understand its limitations or its
inherent risks.
Example 2
(Proper Description of a Security)
Olivia Thomas, an analyst at Government Brokers, Inc., which
is a brokerage firm specializing in government bond trading, has produced a
report that describes an investment strategy designed to benefit from an
expected decline in U.S. interest rates. The firm's derivative products group
has designed a structured product that will allow the firm's clients to benefit
from this strategy. Thomas's report describing the strategy indicates that high
returns are possible if various scenarios for declining interest rates are
assumed. Citing the proprietary nature of the structured product underlying the
strategy, the report does not describe in detail how the firm is able to offer
such returns or the related risks in the scenarios, nor does the report address
the likely returns of the strategy if, contrary to expectations, interest rates
rise.
Comment: Thomas has violated Standard V (B) because her report
fails to describe properly the basic characteristics of the actual and implied
risks of the investment strategy, including how the structure was created and
the degree to which leverage was embedded in the structure. The report should
include a balanced discussion of how the strategy would perform in the case of
rising as well as falling interest rates, preferably illustrating how the
strategies might be expected to perform in the event of a reasonable variety of
interest rate and credit risk—spread scenarios. If liquidity issues are
relevant with regard to the valuation of either the derivatives or the
underlying securities, provisions the firm has made to address those risks
should also be disclosed.
Example 3 (Notification of Changes
to the Investment Process)
RJZ Capital Management is an
active value-style equity manager that selects stocks by using a combination of
four multifactor models. The firm has found favorable results when backtesting
the most recent 10 years of available market data in a new dividend discount
model (DDM) designed by the firm. This model is based on projected inflation
rates, earnings growth rates, and interest rates. The president of RJZ decides
to replace its simple model that uses price to trailing 12-month earnings with
the new DDM.
Comment: Because the introduction
of a new and different valuation model represents a material change in the
investment process, RJZ's president must communicate the change to the firm's
clients. R.JZ is moving away from a model based on hard data toward a new model
that is at least partly dependent on the firm's forecasting skills. Clients
would likely view such a model as a significant change rather than a mere
refinement of RJZ's process.
Example 4 (Notification of Changes
to the Investment Process)
RJZ Capital Management loses the chief architect of its multifactor valuation
system. Without informing its clients, the president of RJZ decides to redirect
the firm's talents and resources toward developing a product for passive equity
management—a product that will emulate the performance of a major market index.
Comment: By failing to disclose to
clients a substantial change to its investment process, the president of RJZ
has violated Standard V(B).
Example 5 (Sufficient Disclosure
of Investment System)
Amanda Chinn is the investment director for
Diversified Asset Management, which manages the endowment of a charitable
organization. Because of recent staff departures, Diversified has decided to
limit its direct investment focus to large-cap securities and supplement the
needs for small-cap and mid-cap management by hiring outside fund managers. In
describing the planned strategy change to the charity, Chinn's update letter
states, "As investment director, I will directly oversee the investment
team managing the endowment's large-capitalization allocation. I will
coordinate the selection and ongoing review of external managers responsible
for allocations to other classes." The letter also describes the reasons
for the change and the characteñstics external managers must have to be
considered.
Comment: Standard V(B) requires
the disclosure of the investment process used to construct the portfolio of the
fund. Changing the investment process from managing all classes of investments
within the firm to the use of external managers is one example of information
that needs to be communicated to clients. Chinn and her firm have embraced the
principles of Standard V(B) by providing their client with relevant
information. The charity can now make a reasonable decision about whether
Diversified Asset Management remains the appropriate manager for its fund.
Example 6
(Notification of Risks and Limitations)
Quantitative
analyst Yuri Yakovlev has developed an investment strategy that selects
small-cap stocks on the basis of quantitative signals. Yakovlev's strategy
typically identifies only a small number of stocks ( 10—20) that tend to be
illiquid, but according to his backtests, the strategy generates significant
risk-adjusted returns. The partners at Yakovlev's firm, QSC Capital, are
impressed by these results. After a thorough examination of the strategy's
risks, stress testing, historical backtesting, and scenario analysis, QSC
decides to seed the strategy with US$IO million of internal capital in order
for Yakovlev to create a track record for the strategy.
After two years,
the strategy has generated performance returns greater than the appropriate
benchmark and the Sharpe ratio of the fund is close to 1.0. On the basis of
these results, QSC decides to actively market the fund to large institutional
investors. While creating the offering materials, Yakovlev informs the
marketing team that the capacity of the strategy is limited. The extent of
the limitation is difficult to ascertain with precision; it depends on market
liquidity and other factors in his model that can evolve over time. Yakovlev
indicates that given the current market conditions, investments in the fund
beyond US$ 100 million of capital could become more difficult and negatively
affect expected fund returns.
Alan Wellard, the manager of the marketing team, is a partner with 30
years of marketing experience and explains to Yakovlev that these are complex
technical issues that will muddy the marketing message. According to Wellard,
the offering material should focus solely on the great track record of the
fund. Yakovlev does not object, because the fund has only US$12 million of
capital, very far from the US$IOO million threshold.
Comment:
Yakovlev and Wellard have not appropriately disclosed a significant
limitation associated with the investment product. Yakovlev believes this
limitation, once reached, will materially affect the returns of the fund.
Although the fund is currently far from the US$IOO million mark, current and
prospective investors must be made aware of this capacity issue. If
significant limitations are complicated to grasp and clients do not have the
technical background required to understand them, Yakovlev and Wellard should
either educate the clients or ascertain whether the fund is suitable for each
client.
Example 7 (Notification of Risks
and Limitations)
Brickell Advisers offers investment advisory services mainly to South American
clients. Julietta Ramon, a risk analyst at Brick-ell, describes to clients how
the firm uses value at risk (VaR) analysis to track the risk of its strategies.
Ramon assures clients that calculating a VaR at a 99% confidence level, using a
20-day holding period, and applying a methodology based on an ex ante Monte
Carlo simulation is extremely effective. The firm has never had losses greater
than those predicted by this VaR analysis.
Comment: Ramon has not
sufficiently communicated the risks associated with the investment process to
satisfy the requirements of Standard V(B). The losses predicted by a VaR
analysis depend greatly on the inputs used in the model. The size and probability
of losses can differ significantly from what an individual model predicts.
Ramon must disclose how the inputs were selected and the potential limitations
and risks associated with the investment strategy.
Example 8 (Notification of Risks and Limitations)
Lily Smith attended an industry conference and noticed that
John Baker, an investment manager with Baker Associates, attracted a great deal
of attention from the conference participants. On the basis of her knowledge of
Baker's reputation and the interest he received at the conference, Smith
recommends adding Baker Associates to the approved manager platform. Her
recommendation to the approval committee includes the statement "John
Baker is well respected in the industry, and his insights are consistently
sought after by investors. Our clients are sure to benefit from investing with
Baker Associates."
Comment: Smith is not appropriately separating facts from
opinions in her recommendation to include the manager within the platform. Her
actions conflict with the requirements of Standard V(B). Smith is relying on
her opinions about Baker's reputation and the fact that many attendees were
talking with him at the conference. Smith should also review the requirements
of Standard V(A) regarding reasonable basis to determine the level of review
necessary to recommend Baker Associates.
Standard V (C) Record
Retention
The Standard
Members and
candidates must develop and maintain appropriate records to support their
investment analyses, recommendations, actions, and other investment-related
communications with clients and prospective clients.
Guidance
Members and candidates must retain records that substantiate the scope of their
research and reasons for their actions or conclusions. The retention
requirement applies to decisions to buy or sell a security as well as reviews
undertaken that do not lead to a change in position.
Records may be maintained either
in hard copy or electronic form.
New Media Records
Members and candidates should
understand that although employers and local regulators are developing digital
media retention policies, these policies may lag behind the advent of new
communication channels. Such lag places greater responsibility on the
individual for ensuring that all relevant information is retained. Examples of
nonprint media formats that should be retained include, but are not limited to
e-mails, text messages, blog posts, and Twitter posts.
Records Are Property of the
Firm
As a general matter, records
created as part of a member's or candidate's professional activity on behalf of
his or her employer are the property of the firm. 
When a member or candidate leaves a firm to seek other
employment, the member or candidate cannot take the property of the firm,
including original forms or copies of supporting records of the member's or
candidate's work, to the new employer without the express consent of the
previous employer.
The member or candidate cannot use
historical recommendations or research reports created at the previous firm
because the supporting documentation is unavailable. 
For
future use, the member or candidate must re-create the supporting records at
the new firm with information gathered through public sources or directly from
the covered company and not from memory or sources obtained at the previous
employer.
Local Requirements
Local regulators and firms may
also implement policies detailing the applicable time frame for retaining
research and client communication records. Fulfilling such regulatory and firm
requirements satisfies the requirements of Standard V(C).
In the absence of regulatory
guidance or firm policies, CFA Institute recommends maintaining records for at
least seven years.
Recommended Procedures for
Compliance
The responsibility to
maintain records that support investment action generally falls with the firm
rather than individuals. Members and candidates must, however, archive research
notes and other documents, either electronically or in hard copy, that support
their current investment-related communications.
Application of the
Standard
Example 1 (Record Retention and Research Process)
Malcolm Young is a research analyst who writes numerous
reports rating companies in the luxury retail industry. His reports are based
on a variety of sources, including interviews with company managers,
manufacturers, and economists; on-site company visits; customer surveys; and
secondary research from analysts covering related industries.
Comment: Young must carefully document and keep copies of all the information
that goes into his reports, including the secondary or third-party research of
other analysts. Failure to maintain such files would violate Standard V(C).
Example 2 (Record Retention and Research Process)
Martin Blank develops an analytical model while he is employed
by Green Partners Investment Management, LLP (GPIM). While at the firm, he systematically
documents the assumptions that make up the model as well as his reasoning
behind the assumptions. As a result of the success of his model, Blank is hired
to be the head of the research department of one of GPIM's competitors. Blank
takes copies of the records supporting his model to his new firm.
Comment: The records created by Blank supporting the research
model he developed at GPIM are the records of GPIM. Taking the documents with
him to his new employer without GPIM's permission violates Standard V(C). To
use the model in the future, Blank must re-create the records supporting his
model at the new firm.
LESSON 6: STANDARD VI:
CONFLICTS OF INTEREST
Disclosure of Conflicts B.
Priority of Transactions
c. Referral Fees
Standard VI(A) Disclosure
of Conflicts
The Standard
Members and candidates must
make full and fair disclosure of all matters that could reasonably be expected
to impair their independence and objectivity or interfere with respective
duties to their clients, prospective clients, and employer. Members and
candidates must ensure that such disclosures are prominent, are delivered in
plain language, and communicate the relevant information effectively.
Guidance
Best practice is to avoid
actual conflicts or the appearance of conflicts of interest when possible.
Conflicts of interest often arise in the investment profession.
When conflicts cannot be
reasonably avoided, clear and complete disclosure of their existence is
necessary.
In making and updating
disclosures of conflicts of interest, members and candidates should err on the
side of caution to ensure that conflicts are effectively communicated.
Disclosure of Conflicts
to Employers
When reporting conflicts of interest to employers, members and candidates must
give their employers enough information to assess the impact of the conflict. 
Members and candidates must take reasonable steps to avoid conflicts
and, if they occur inadvertently, must report them promptly so that the
employer and the member or candidate can resolve them as quickly and
effectively as possible. 
Any potential conflict situation that could prevent clear
judgment about or full commitment to the execution of a member's or candidate's
duties to the employer should be reported to the member's or candidate's
employer and promptly resolved.
Disclosure to Clients
The most obvious conflicts
of interest, which should always be disclosed, are relationships between an
issuer and the member, the candidate, or his or her firm (such as a
directorship or consultancy by a member; investment banking, underwriting, and
financial relationships; broker/dealer market-making activities; and material
beneficial ownership of stock).
Disclosures should be made
to clients regarding fee arrangements, subadvisory agreements, or other
situations involving nonstandard fee structures. Equally important is the
disclosure of arrangements in which the firm benefits directly from investment
recommendations. An obvious conflict of interest is the rebate of a portion of
the service fee some classes of mutual funds charge to investors.
Cross-Departmental Conflicts
Other circumstances can
give rise to actual or potential conflicts of interest. For instance:
A sell-side analyst working
for a broker/dealer may be encouraged, not only by members of her or his own
firm but by corporate issuers themselves, to write research reports about
particular companies. 
A buy-side analyst is likely to be faced with
similar conflicts as banks exercise their underwriting and security-dealing
powers.
The marketing division may
ask an analyst to recommend the stock of a certain company in order to obtain
business from that company. 
Members, candidates, and their firms should attempt to resolve
situations presenting potential conflicts of interest or disclose them in
accordance with the principles set forth in Standard VI(A).
Conflicts with Stock
Ownership
The most prevalent conflict
requiring disclosure under Standard VI(A) is a member's or candidate's
ownership of stock in companies that he or she recommends to clients or that
clients hold. Clearly, the easiest method for preventing a conflict is to
prohibit members and candidates from owning any such securities, but this
approach is overly burdensome and discriminates against members and candidates.
Therefore:
Sell-side members and candidates should
disclose any materially beneficial ownership interest in a security or other
investment that the member or candidate is recommending.
Buy-side members and
candidates should disclose their procedures for reporting requirements for
personal transactions.
Conflicts as a Director
Service as a director poses
three basic conflicts of interest.
A conflict may exist between the duties owed
to clients and the duties owed to shareholders of the company.
Investment personnel who
serve as directors may receive the securities or options to purchase securities
of the company as compensation for serving on the board, which could raise
questions about trading actions that might increase the value of those
securities.
Board service creates the
opportunity to receive material nonpublic information involving the company.
When members or candidates providing investment services also serve as
directors, they should be isolated from those making investment decisions by
the use of firewalls or similar restrictions.
Recommended Procedures for
Compliance
Members or candidates
should 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.
Members' and candidates'
firms are encouraged to include information on compensation packages in firms'
promotional literature.
Application of the
Standard
Example
1 (Conflict of Interest and Business Relationships)
Hunter Weiss is a research analyst with
Farmington Company, a broker and investment banking firm. Farmington's merger
and acquisition department has represented Vimco, a conglomerate, in all of
Vimco's acquisitions for 20 years. From time to time, Farmington officers sit
on the boards of directors of various Vimco subsidiaries. Weiss is writing a
research report on Vimco.
Comment:
Weiss must disclose in his research report Farmington's special relationship
with Vimco. Broker/dealer management of and participation in public offerings
must be disclosed in research reports. Because the position of underwriter to a
company entails a special past and potential future relationship with a company
that is the subject of investment advice, it threatens the independence and
objectivity of the report writer and must be disclosed.
Example 2 (Conflict of Interest and Business Stock Ownership)
The investment management firm of Dover & Roe sells a 25%
interest in its partnership to a multinational bank holding company, First of
New York. Immediately after the sale, Margaret Hobbs, president of Dover &
Roe, changes her recommendation for First of New York's common stock from
"sell" to "buy" and adds First of New York's commercial
paper to Dover & Roe's approved list for purchase.
Comment: Hobbs must disclose the new relationship with First
of New York to all Dover & Roe clients. This relationship must also be
disclosed to clients by the firm's portfolio managers when they make specific
investment recommendations or take investment actions with respect to First of
New York's securities.
Example 3 (Conflict of Interest
and Personal Stock Ownership)
Carl Fargmon, a
research analyst who follows firms producing office equipment, has been
recommending purchase of Kincaid Printing because of its innovative new line of
copiers. After his initial report on the company, Fargmon's wife inherits from
a distant relative
US$-3 million of Kincaid stock. He
has been asked to write a follow-up report on Kincaid.
Comment: Fargmon must disclose his wife's ownership of the Kincaid stock to his
employer and in his follow-up report. Best practice would be to avoid the conflict
by asking his employer to assign another analyst to draft the follow-up report.
Example 4 (Conflict of Interest and Personal Stock Ownership)
Betty Roberts is speculating in penny stocks for her own
account and purchases 100,000 shares of Drew Mining, Inc., for USS0.30 a share.
She intends to sell these shares at the sign of any substantial upward price
movement of the stock. A week later, her employer asks her to write a report on
penny stocks in the mining industry to be published in two weeks. Even without
owning the Drew stock, Roberts would recommend it in her report as a
"buy." A surge in the price of the stock to the US$2 range is likely
to result once the report is issued.
Comment: Although this holding may not be material, Roberts
must disclose it in the report and to her employer before writing the report
because the gain for her will be substantial if the market responds strongly to
her recommendation. The fact that she has only recently purchased the stock
adds to the appearance that she is not entirely objective.
Example
5 (Conflict of Interest and Compensation Arrangements)
Gary
Carter is a representative with Bengal International, a registered
broker/dealer. Carter is approached by a stock promoter for Badger Company, who
offers to pay Carter additional compensation for sales of Badger Company's
stock to Carter's clients. Carter accepts the stock promoter's offer but does
not disclose the arrangements to his clients or to his employer. Carter sells
shares of the stock to his clients.
Comment: Carter has violated Standard VI(A) by failing to
disclose to clients that he is receiving additional compensation for
recommending and selling Badger stock. Because he did not disclose the
arrangement with Badger to his clients, the clients were unable to evaluate
whether Carter's recommendations to buy Badger were affected by this
arrangement. Carter's conduct also violated Standard VI(A) by failing to
disclose to his employer monetary compensation received in addition to the
compensation and benefits conferred by his employer. Carter was required by
Standard VI(A) to disclose the arrangement with Badger to his employer so that
his employer could evaluate whether the arrangement affected Carter's
objectivity and loyalty.
Example 6 (Conflict of Interest and Directorship)
Carol Corky, a senior portfolio manager for Universal
Management, recently became involved as a trustee with the Chelsea Foundation,
a large not-for-profit foundation in her hometown. Universal is a small money
manager (with assets under management of approximately USSI 00 million) that
caters to individual investors. Chelsea has assets in excess of USS2 billion.
Corky does not believe informing Universal of her involvement with Chelsea is
necessary.
Comment: By failing to inform Universal of her involvement with Chelsea, Corky
violated Standard VI(A). Given the large size of the endowment at Chelsea,
Corky's new role as a trustee can reasonably be expected to be time consuming,
to the possible detriment of Corky's portfolio responsibilities with Universal.
Also, as a trustee, Corky may become involved in the investment decisions at
Chelsea. Therefore, Standard VI(A) obligates Corky to discuss becoming a
trustee at Chelsea with her compliance officer or supervisor at Universal
before accepting the position, and she should have disclosed the degree to
which she would be involved in investment decisions at Chelsea.
Example 7 (Conflict of Interest and Requested Favors)
Michael Papis is the chief investment officer of his state's
retirement fund. The fund has always used outside advisers for the real estate
allocation, and this information is clearly presented in all fund
communications. Thomas Nagle, a recognized sell-side research analyst and
Papis's business school classmate, recently left the investment bank he worked
for to start his own asset management firm, Accessible Real Estate. Nagle is
trying to build his assets under management and contacts Papis about gaining
some of the retirement fund's allocation. In the previous few years, the
performance of the retirement fund's real estate investments was in line with
the fund's benchmark but was not extraordinary. Papis decides to help out his
old friend and also to seek better returns by moving the real estate allocation
to Accessible. The only notice of the change in adviser appears in the next
annual report in the listing of associated advisers.
Comment: Papis has violated Standard VI(A) by not disclosing
to his employer his personal relationship with Nagle. Disclosure of his past
history with Nagle would allow his firm to determine whether the conflict may
have impaired Papis's independence in deciding to change managers.
See also Standard IV(C)—Responsibilities of Supervisors, Standard
V(A)—Diligence and Reasonable Basis, and Standard V(B)—Communication with
Clients and Prospective Clients.
Example 8
(Conflict of Interest and Business Relationships)
Bob Wade, trust
manager for Central Midas Bank, was approached by Western Funds about
promoting its family of funds, with special interest in the service-fee
class. To entice Central to promote this class, Western Funds offered to pay
the bank a service fee of 0.25%. Without disclosing the fee being offered to
the bank, Wade asked one of the investment managers to review the Western
Funds family of funds to determine whether they were suitable for clients of
Central. The manager completed the normal due diligence review and determined
that the funds were fairly valued in the market with fee structures on a par
with their competitors. Wade decided to accept Western's offer and instructed
the team of portfolio managers to exclusively promote these funds and the
service-fee class to clients seeking to invest new funds or transfer from
their current investments. So as to not influence the investment managers,
Wade did not disclose the fee offer and allowed that income to flow directly
to the bank.
Comment:
Wade is violating Standard VI(A) by not disclosing the portion of the service
fee being paid to Central. Although the investment managers may not be
influenced by the fee, neither they nor the client have the proper
information about Wade's decision to exclusively market this fund family and
class of investments. Central may come to rely on the new fee as a component
of the firm's profitability and may be unwilling to offer other products in
the future that could affect the fees received.
(See also Standard 
and Objectivity.)
Example 9 (Disclosure of Conflicts
to Employers)
Yehudit Dagan is a portfolio
manager for Risk Management Bank (RMB), whose clients include retirement plans
and corporations. RMB provides a defined contribution retirement plan for its
employees that offers 20 large diversified mutual fund investment options,
including a mutual fund managed by Dagan's RMB colleagues. After being employed
for six months, Dagan became eligible to participate in the retirement plan,
and she intends to allocate her retirement plan assets in six of the investment
options, including the fund managed by her RMB colleagues. Dagan is concerned
that joining the plan will lead to a potentially significant amount of
paperwork for her (e.g., disclosure of her retirement account holdings and
needing preclearance for her transactions), especially with her investing in
the in-house fund.
Comment:
Standard VI(A) would not require Dagan to disclosure her personal or retirement
investments in large diversified mutual funds, unless specifically required by
her employer. For practical reasons, the standard does not require Dagan to
gain preclearance for ongoing payroll deduction contributions to retirement
plan account investment options.
Dagan
should ensure that her firm does not have a specific policy regarding
investment— whether personal or in the retirement account—for funds managed by
the company's employees. These mutual funds may be subject to the company's
disclosure, preclearance, and trading restriction procedures to identify
possible conflicts prior to the execution of trades.
Standard VI(B) Priority
of Transactions
The Standard
Investment transactions
for clients and employers must have priority over investment transactions in
which a member or candidate is the beneficial owner.
Guidance
This standard is designed to
prevent any potential conflict of interest or the appearance of a conflict of
interest with respect to personal transactions.
Client interests have priority.
Client transactions must take precedence over transactions made on behalf of
the member's or candidate's firm or personal transactions.
Avoiding Potential
Conflicts
Although conflicts of interest
exist, nothing is inherently unethical about individual managers, advisers, or
mutual fund employees making money from personal investments as long as (l) the
client is not disadvantaged by the trade, (2) the investment professional does
not benefit personally from trades undertaken for clients, and (3) the
investment professional complies with applicable regulatory requirements.
Some situations occur in which a member or candidate may need to enter a
personal transaction that runs counter to current recommendations or what the
portfolio manager is doing for client portfolios. In these situations, the same
three criteria given in the preceding paragraph should be applied in the
transaction so as to not violate Standard VI(B).
Personal Trading Secondary
to frading for Clients
The objective of the standard is
to prevent personal transactions from adversely affecting the interests of clients
or employers. A member or candidate having the same investment positions or
being co-invested with clients does not always create a conflict.
Personal investment positions or
transactions of members or candidates or their firm should never, however, adversely
affect client investments.
Standards for Nonpublic
Information
Standard VI(B) covers the
activities of members and candidates who have knowledge of pending transactions
that may be made on behalf of their clients or employers, who have access to nonpublic
information during the normal preparation of research recommendations, or who
take investment actions. 
Members and candidates are prohibited from conveying
nonpublic information to any person whose relationship to the member or
candidate makes the member or candidate a beneficial owner of the person's
securities.
Members and candidates must not
convey this information to any other person if the nonpublic information can be
deemed material.
Impact on All Accounts
with Beneficial Ownership
Members or candidates may
undertake transactions in accounts for which they are a beneficial owner only
after their clients and employers have had adequate opportunity to act on a
recommendation.
Personal transactions include
those made for the member's or candidate's own account, for family (including
spouse, children, and other immediate family members) accounts, and for
accounts in which the member or candidate has a direct or indirect pecuniary
interest, such as a trust or retirement account. 
Family accounts that are client accounts should be treated
like any other firm account and should neither be given special treatment nor
be disadvantaged because of the family relationship. If a member or candidate
has a beneficial ownership in the account, however, the member or candidate may
be subject to preclearance or reporting requirements of the employer or
applicable law.
Recommended Procedures
for Compliance
Members and candidates should urge
their firms to establish such policies and procedures.
The specific provisions of each
firm's standards will vary, but all firms should adopt certain basic procedures
to address the conflict areas created by personal investing. These procedures
include the following:
Limited participation in equity IPOs. 
Restrictions on private placements. o
Establish blackout/restricted periods. o Reporting requirements, including:
Disclosure of holdings in which the
employee has a beneficial interest.
Providing duplicate confirmations
of transactions.
Preclearance procedures.
Disclosure of policies to
investors.
Application of the Standard
Example 1 (Personal Trading)
Research analyst Marlon Long does not recommend purchase of a
common stock for his employer's account because he wants to purchase the stock
personally and does not want to wait until the recommendation is approved and
the stock is purchased by his employer.
Comment: Long has violated Standard VI(B) by taking advantage
of his knowledge of the stock's value before allowing his employer to benefit
from that information.
Example
2 (frading for Family Member Account)
Carol Baker, the portfolio manager of an
aggressive growth mutual fund, maintains an account in her husband's name at
several brokerage firms with which the fund and a number of Baker's other
individual clients do a substantial amount of business. Whenever a hot issue
becomes available, she instructs the brokers to buy it for her husband's
account. Because such issues normally are scarce, Baker often acquires shares
in hot issues but her clients are not able to participate in them.
Comment:
To avoid violating Standard VI(B), Baker must acquire shares for her mutual
fund first and acquire them for her husband's account only after doing so, even
though she might miss out on participating in new issues via her husband's
account. She also must disclose the trading for her husband's account to her
employer because this activity creates a conflict between her personal
interests and her employer's interests.
Example 3 (Trading Prior
to Report Dissemination)
A
brokerage's insurance analyst, Denise Wilson, makes a closed-circuit TV
report to her firm's branches around the country. During the broadcast, she
includes negative comments about a major company in the insurance industry.
The following day, Wilson's report is printed and distributed to the sales
force and public customers. The report recommends that both short-term
traders and intermediate investors take profits by selling that insurance
company's stock. Seven minutes after the broadcast, however, Ellen Riley,
head of the firm's trading department, had closed out a long "call"
position in the stock. Shortly thereafter, Riley established a sizable
"put" position in the stock. When asked about her activities, Riley
claimed she took the actions to facilitate anticipated sales by institutional
clients.
Comment:
Riley did not give customers an opportunity to buy or sell in the options
market before the firm itself did. By taking action before the report was
disseminated, Riley's firm may have depressed the price of the calls and
increased the price of the puts. The firm could have avoided a conflict of
interest if it had waited to trade for its own account until its clients had
an opportunity to receive and assimilate Wilson's recommendations. As it is,
Riley's actions violated Standard VI(B).
Standard VI(C) Re-feral
Fees
The Standard
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.
Guidance
Members and candidates must inform
their employer, clients, and prospective clients of any benefit received for
referrals of customers and clients.
Members and candidates must disclose when they pay a fee or provide
compensation to others who have referred prospective clients to the member or
candidate. 
Appropriate disclosure means that members and candidates must advise
the client or prospective client, before entry into any formal agreement for
seNices, of any benefit given or received for the recommendation of any
services provided by the member or candidate. In addition, the member or
candidate must disclose the nature of the consideration or benefit
Recommended Procedures for
Compliance
Members and candidates should
encourage their employers to develop procedures related to referral fees. The
firm may completely restrict such fees. If the firm does not adopt a strict
prohibition of such fees, the procedures should indicate the appropriate steps
for requesting approval.
Employers should have investment
professionals provide to the clients notification of approved referral fee
programs and provide the employer regular (at least quarterly) updates on the
amount and nature of compensation received.
Application of the
Standard
Example 1
(Disclosure of Interdepartmental Referral Arrangements)
James Handley works for the trust
department of Central Trust Bank. He receives compensation for each referral he
makes to Central Trust's brokerage department and personal financial management
department that results in a sale. He refers several of his clients to the
personal financial management department but does not disclose the arrangement
within Central Trust to his clients.
Comment: Handley has violated
Standard VIC) by not disclosing the referral arrangement at Central Trust Bank
to his clients. Standard VIC) does not distinguish between referral payments
paid by a third party for referring clients to the third party and internal
payments paid within the firm to attract new business to a subsidiary. Members
and candidates must disclose all such referral fees. Therefore, Handley is
required to disclose, at the time of referral, any referral fee agreement in
place among Central Trust Bank's departments. The disclosure should include the
nature and the value of the benefit and should be made in writing.
Example 2 (Disclosure of Referral
Arrangements and Informing Firm)
Katherine Roberts is a portfolio manager at Katama Investments, an advisory
firm specializing in managing assets for high-net-worth individuals. Katama's
trading desk uses a variety of brokerage houses to execute trades on behalf of
its clients. Roberts asks the trading desk to direct a large portion of its
commissions to Naushon, Inc., a small broker/dealer run by one of Roberts's
business school classmates. Katama's traders have found that Naushon is not
very competitive on pricing, and although Naushon generates some research for
its trading clients, Katama's other analysts have found most of Naushon's
research to be not especially useful. Nevertheless, the traders do as Roberts
asks, and in return for receiving a large portion of Katama's business, Naushon
recommends the investment services of Roberts and Katama to its wealthiest
clients. This arrangement is not disclosed to either Katama or the clients
referred by Naushon.
Comment: Roberts is violating
Standard VIC) by failing to inform her employer of the referral arrangement.
Example 3 (Disclosure of Referral Arrangements and Outside
Organizations)
Alex Burl is a portfolio manager at Helpful Investments, a
local investment advisory firm. Burl is on the advisory board of his child's
school, which is looking for ways to raise money to purchase new playground
equipment for the school. Burl discusses a plan with his supervisor in which he
will donate to the school a portion of his service fee from new clients
referred by the parents of students at the school. Upon getting the approval
from Helpful, Burl presents the idea to the school's advisory board and
directors. The school agrees to announce the program at the next parent event
and asks Burl to provide the appropriate written materials to be distributed. A
week following the distribution of the fliers, Burl receives the first
school-related referral. In establishing the client's investment policy
statement, Burl clearly discusses the school's referral and outlines the plans
for distributing the donation back to the school.
Comment: Burl has not violated Standard VI(C)
because he secured the permission of his employer, Helpful Investments, and the
school prior to beginning the program and because he discussed the arrangement
with the client at the time the investment policy statement was designed.
Olivia Thomas, an analyst at Government Brokers, Inc., which
is a brokerage firm specializing in government bond trading, has produced a
report that describes an investment strategy designed to benefit from an
expected decline in U.S. interest rates. The firm's derivative products group
has designed a structured product that will allow the firm's clients to benefit
from this strategy. Thomas's report describing the strategy indicates that high
returns are possible if various scenarios for declining interest rates are
assumed. Citing the proprietary nature of the structured product underlying the
strategy, the report does not describe in detail how the firm is able to offer
such returns or the related risks in the scenarios, nor does the report address
the likely returns of the strategy if, contrary to expectations, interest rates
rise.
Comment: Thomas has violated Standard V (B) because her report
fails to describe properly the basic characteristics of the actual and implied
risks of the investment strategy, including how the structure was created and
the degree to which leverage was embedded in the structure. The report should
include a balanced discussion of how the strategy would perform in the case of
rising as well as falling interest rates, preferably illustrating how the
strategies might be expected to perform in the event of a reasonable variety of
interest rate and credit risk—spread scenarios. If liquidity issues are
relevant with regard to the valuation of either the derivatives or the
underlying securities, provisions the firm has made to address those risks
should also be disclosed.
Example 3 (Notification of Changes
to the Investment Process)
RJZ Capital Management is an
active value-style equity manager that selects stocks by using a combination of
four multifactor models. The firm has found favorable results when backtesting
the most recent 10 years of available market data in a new dividend discount
model (DDM) designed by the firm. This model is based on projected inflation
rates, earnings growth rates, and interest rates. The president of RJZ decides
to replace its simple model that uses price to trailing 12-month earnings with
the new DDM.
Comment: Because the introduction
of a new and different valuation model represents a material change in the
investment process, RJZ's president must communicate the change to the firm's
clients. R.JZ is moving away from a model based on hard data toward a new model
that is at least partly dependent on the firm's forecasting skills. Clients
would likely view such a model as a significant change rather than a mere
refinement of RJZ's process.
Example 4 (Notification of Changes
to the Investment Process)
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RJZ Capital Management loses the chief architect of its multifactor valuation
system. Without informing its clients, the president of RJZ decides to redirect
the firm's talents and resources toward developing a product for passive equity
management—a product that will emulate the performance of a major market index.
Comment: By failing to disclose to
clients a substantial change to its investment process, the president of RJZ
has violated Standard V(B).
Example 5 (Sufficient Disclosure
of Investment System)
Amanda Chinn is the investment director for
Diversified Asset Management, which manages the endowment of a charitable
organization. Because of recent staff departures, Diversified has decided to
limit its direct investment focus to large-cap securities and supplement the
needs for small-cap and mid-cap management by hiring outside fund managers. In
describing the planned strategy change to the charity, Chinn's update letter
states, "As investment director, I will directly oversee the investment
team managing the endowment's large-capitalization allocation. I will
coordinate the selection and ongoing review of external managers responsible
for allocations to other classes." The letter also describes the reasons
for the change and the characteñstics external managers must have to be
considered.
Comment: Standard V(B) requires
the disclosure of the investment process used to construct the portfolio of the
fund. Changing the investment process from managing all classes of investments
within the firm to the use of external managers is one example of information
that needs to be communicated to clients. Chinn and her firm have embraced the
principles of Standard V(B) by providing their client with relevant
information. The charity can now make a reasonable decision about whether
Diversified Asset Management remains the appropriate manager for its fund.
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Example 6
(Notification of Risks and Limitations) Quantitative
analyst Yuri Yakovlev has developed an investment strategy that selects
small-cap stocks on the basis of quantitative signals. Yakovlev's strategy
typically identifies only a small number of stocks ( 10—20) that tend to be
illiquid, but according to his backtests, the strategy generates significant
risk-adjusted returns. The partners at Yakovlev's firm, QSC Capital, are
impressed by these results. After a thorough examination of the strategy's
risks, stress testing, historical backtesting, and scenario analysis, QSC
decides to seed the strategy with US$IO million of internal capital in order
for Yakovlev to create a track record for the strategy. After two years,
the strategy has generated performance returns greater than the appropriate
benchmark and the Sharpe ratio of the fund is close to 1.0. On the basis of
these results, QSC decides to actively market the fund to large institutional
investors. While creating the offering materials, Yakovlev informs the
marketing team that the capacity of the strategy is limited. The extent of
the limitation is difficult to ascertain with precision; it depends on market
liquidity and other factors in his model that can evolve over time. Yakovlev
indicates that given the current market conditions, investments in the fund
beyond US$ 100 million of capital could become more difficult and negatively
affect expected fund returns. Alan Wellard, the manager of the marketing team, is a partner with 30
years of marketing experience and explains to Yakovlev that these are complex
technical issues that will muddy the marketing message. According to Wellard,
the offering material should focus solely on the great track record of the
fund. Yakovlev does not object, because the fund has only US$12 million of
capital, very far from the US$IOO million threshold. Comment:
Yakovlev and Wellard have not appropriately disclosed a significant
limitation associated with the investment product. Yakovlev believes this
limitation, once reached, will materially affect the returns of the fund.
Although the fund is currently far from the US$IOO million mark, current and
prospective investors must be made aware of this capacity issue. If
significant limitations are complicated to grasp and clients do not have the
technical background required to understand them, Yakovlev and Wellard should
either educate the clients or ascertain whether the fund is suitable for each
client. |
Example 7 (Notification of Risks
and Limitations)
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Brickell Advisers offers investment advisory services mainly to South American
clients. Julietta Ramon, a risk analyst at Brick-ell, describes to clients how
the firm uses value at risk (VaR) analysis to track the risk of its strategies.
Ramon assures clients that calculating a VaR at a 99% confidence level, using a
20-day holding period, and applying a methodology based on an ex ante Monte
Carlo simulation is extremely effective. The firm has never had losses greater
than those predicted by this VaR analysis.
Comment: Ramon has not
sufficiently communicated the risks associated with the investment process to
satisfy the requirements of Standard V(B). The losses predicted by a VaR
analysis depend greatly on the inputs used in the model. The size and probability
of losses can differ significantly from what an individual model predicts.
Ramon must disclose how the inputs were selected and the potential limitations
and risks associated with the investment strategy.
Example 8 (Notification of Risks and Limitations)
Lily Smith attended an industry conference and noticed that
John Baker, an investment manager with Baker Associates, attracted a great deal
of attention from the conference participants. On the basis of her knowledge of
Baker's reputation and the interest he received at the conference, Smith
recommends adding Baker Associates to the approved manager platform. Her
recommendation to the approval committee includes the statement "John
Baker is well respected in the industry, and his insights are consistently
sought after by investors. Our clients are sure to benefit from investing with
Baker Associates."
Comment: Smith is not appropriately separating facts from
opinions in her recommendation to include the manager within the platform. Her
actions conflict with the requirements of Standard V(B). Smith is relying on
her opinions about Baker's reputation and the fact that many attendees were
talking with him at the conference. Smith should also review the requirements
of Standard V(A) regarding reasonable basis to determine the level of review
necessary to recommend Baker Associates.
Standard V (C) Record
Retention
The Standard
Members and
candidates must develop and maintain appropriate records to support their
investment analyses, recommendations, actions, and other investment-related
communications with clients and prospective clients.
Guidance
|
Members and candidates must retain records that substantiate the scope of their
research and reasons for their actions or conclusions. The retention
requirement applies to decisions to buy or sell a security as well as reviews
undertaken that do not lead to a change in position.
Records may be maintained either
in hard copy or electronic form.
New Media Records
Members and candidates should
understand that although employers and local regulators are developing digital
media retention policies, these policies may lag behind the advent of new
communication channels. Such lag places greater responsibility on the
individual for ensuring that all relevant information is retained. Examples of
nonprint media formats that should be retained include, but are not limited to
e-mails, text messages, blog posts, and Twitter posts.
Records Are Property of the
Firm
As a general matter, records
created as part of a member's or candidate's professional activity on behalf of
his or her employer are the property of the firm. When a member or candidate leaves a firm to seek other
employment, the member or candidate cannot take the property of the firm,
including original forms or copies of supporting records of the member's or
candidate's work, to the new employer without the express consent of the
previous employer.
The member or candidate cannot use
historical recommendations or research reports created at the previous firm
because the supporting documentation is unavailable. For
future use, the member or candidate must re-create the supporting records at
the new firm with information gathered through public sources or directly from
the covered company and not from memory or sources obtained at the previous
employer.
Local Requirements
Local regulators and firms may
also implement policies detailing the applicable time frame for retaining
research and client communication records. Fulfilling such regulatory and firm
requirements satisfies the requirements of Standard V(C).
In the absence of regulatory
guidance or firm policies, CFA Institute recommends maintaining records for at
least seven years.
Recommended Procedures for
Compliance
The responsibility to
maintain records that support investment action generally falls with the firm
rather than individuals. Members and candidates must, however, archive research
notes and other documents, either electronically or in hard copy, that support
their current investment-related communications.
Application of the
Standard
Example 1 (Record Retention and Research Process)
Malcolm Young is a research analyst who writes numerous
reports rating companies in the luxury retail industry. His reports are based
on a variety of sources, including interviews with company managers,
manufacturers, and economists; on-site company visits; customer surveys; and
secondary research from analysts covering related industries.
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Comment: Young must carefully document and keep copies of all the information
that goes into his reports, including the secondary or third-party research of
other analysts. Failure to maintain such files would violate Standard V(C).
Example 2 (Record Retention and Research Process)
Martin Blank develops an analytical model while he is employed
by Green Partners Investment Management, LLP (GPIM). While at the firm, he systematically
documents the assumptions that make up the model as well as his reasoning
behind the assumptions. As a result of the success of his model, Blank is hired
to be the head of the research department of one of GPIM's competitors. Blank
takes copies of the records supporting his model to his new firm.
Comment: The records created by Blank supporting the research
model he developed at GPIM are the records of GPIM. Taking the documents with
him to his new employer without GPIM's permission violates Standard V(C). To
use the model in the future, Blank must re-create the records supporting his
model at the new firm.
LESSON 6: STANDARD VI:
CONFLICTS OF INTEREST
Disclosure of Conflicts B.
Priority of Transactions
c. Referral Fees
Standard VI(A) Disclosure
of Conflicts
The Standard
Members and candidates must
make full and fair disclosure of all matters that could reasonably be expected
to impair their independence and objectivity or interfere with respective
duties to their clients, prospective clients, and employer. Members and
candidates must ensure that such disclosures are prominent, are delivered in
plain language, and communicate the relevant information effectively.
Guidance
Best practice is to avoid
actual conflicts or the appearance of conflicts of interest when possible.
Conflicts of interest often arise in the investment profession.
When conflicts cannot be
reasonably avoided, clear and complete disclosure of their existence is
necessary.
In making and updating
disclosures of conflicts of interest, members and candidates should err on the
side of caution to ensure that conflicts are effectively communicated.
Disclosure of Conflicts
to Employers
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When reporting conflicts of interest to employers, members and candidates must
give their employers enough information to assess the impact of the conflict. Members and candidates must take reasonable steps to avoid conflicts
and, if they occur inadvertently, must report them promptly so that the
employer and the member or candidate can resolve them as quickly and
effectively as possible. Any potential conflict situation that could prevent clear
judgment about or full commitment to the execution of a member's or candidate's
duties to the employer should be reported to the member's or candidate's
employer and promptly resolved.
Disclosure to Clients
The most obvious conflicts
of interest, which should always be disclosed, are relationships between an
issuer and the member, the candidate, or his or her firm (such as a
directorship or consultancy by a member; investment banking, underwriting, and
financial relationships; broker/dealer market-making activities; and material
beneficial ownership of stock).
Disclosures should be made
to clients regarding fee arrangements, subadvisory agreements, or other
situations involving nonstandard fee structures. Equally important is the
disclosure of arrangements in which the firm benefits directly from investment
recommendations. An obvious conflict of interest is the rebate of a portion of
the service fee some classes of mutual funds charge to investors.
Cross-Departmental Conflicts
Other circumstances can
give rise to actual or potential conflicts of interest. For instance:
A sell-side analyst working
for a broker/dealer may be encouraged, not only by members of her or his own
firm but by corporate issuers themselves, to write research reports about
particular companies. A buy-side analyst is likely to be faced with
similar conflicts as banks exercise their underwriting and security-dealing
powers.
The marketing division may
ask an analyst to recommend the stock of a certain company in order to obtain
business from that company. Members, candidates, and their firms should attempt to resolve
situations presenting potential conflicts of interest or disclose them in
accordance with the principles set forth in Standard VI(A).
Conflicts with Stock
Ownership
The most prevalent conflict
requiring disclosure under Standard VI(A) is a member's or candidate's
ownership of stock in companies that he or she recommends to clients or that
clients hold. Clearly, the easiest method for preventing a conflict is to
prohibit members and candidates from owning any such securities, but this
approach is overly burdensome and discriminates against members and candidates.
Therefore:
Sell-side members and candidates should
disclose any materially beneficial ownership interest in a security or other
investment that the member or candidate is recommending.
Buy-side members and
candidates should disclose their procedures for reporting requirements for
personal transactions.
Conflicts as a Director
Service as a director poses
three basic conflicts of interest.
A conflict may exist between the duties owed
to clients and the duties owed to shareholders of the company.
Investment personnel who
serve as directors may receive the securities or options to purchase securities
of the company as compensation for serving on the board, which could raise
questions about trading actions that might increase the value of those
securities.
Board service creates the
opportunity to receive material nonpublic information involving the company.
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When members or candidates providing investment services also serve as
directors, they should be isolated from those making investment decisions by
the use of firewalls or similar restrictions.
Recommended Procedures for
Compliance
Members or candidates
should 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.
Members' and candidates'
firms are encouraged to include information on compensation packages in firms'
promotional literature.
Application of the
Standard
Example
1 (Conflict of Interest and Business Relationships)
Hunter Weiss is a research analyst with
Farmington Company, a broker and investment banking firm. Farmington's merger
and acquisition department has represented Vimco, a conglomerate, in all of
Vimco's acquisitions for 20 years. From time to time, Farmington officers sit
on the boards of directors of various Vimco subsidiaries. Weiss is writing a
research report on Vimco.
Comment:
Weiss must disclose in his research report Farmington's special relationship
with Vimco. Broker/dealer management of and participation in public offerings
must be disclosed in research reports. Because the position of underwriter to a
company entails a special past and potential future relationship with a company
that is the subject of investment advice, it threatens the independence and
objectivity of the report writer and must be disclosed.
Example 2 (Conflict of Interest and Business Stock Ownership)
The investment management firm of Dover & Roe sells a 25%
interest in its partnership to a multinational bank holding company, First of
New York. Immediately after the sale, Margaret Hobbs, president of Dover &
Roe, changes her recommendation for First of New York's common stock from
"sell" to "buy" and adds First of New York's commercial
paper to Dover & Roe's approved list for purchase.
Comment: Hobbs must disclose the new relationship with First
of New York to all Dover & Roe clients. This relationship must also be
disclosed to clients by the firm's portfolio managers when they make specific
investment recommendations or take investment actions with respect to First of
New York's securities.
Example 3 (Conflict of Interest
and Personal Stock Ownership)
Carl Fargmon, a
research analyst who follows firms producing office equipment, has been
recommending purchase of Kincaid Printing because of its innovative new line of
copiers. After his initial report on the company, Fargmon's wife inherits from
a distant relative
US$-3 million of Kincaid stock. He
has been asked to write a follow-up report on Kincaid.
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Comment: Fargmon must disclose his wife's ownership of the Kincaid stock to his
employer and in his follow-up report. Best practice would be to avoid the conflict
by asking his employer to assign another analyst to draft the follow-up report.
Example 4 (Conflict of Interest and Personal Stock Ownership)
Betty Roberts is speculating in penny stocks for her own
account and purchases 100,000 shares of Drew Mining, Inc., for USS0.30 a share.
She intends to sell these shares at the sign of any substantial upward price
movement of the stock. A week later, her employer asks her to write a report on
penny stocks in the mining industry to be published in two weeks. Even without
owning the Drew stock, Roberts would recommend it in her report as a
"buy." A surge in the price of the stock to the US$2 range is likely
to result once the report is issued.
Comment: Although this holding may not be material, Roberts
must disclose it in the report and to her employer before writing the report
because the gain for her will be substantial if the market responds strongly to
her recommendation. The fact that she has only recently purchased the stock
adds to the appearance that she is not entirely objective.
Example
5 (Conflict of Interest and Compensation Arrangements)
Gary
Carter is a representative with Bengal International, a registered
broker/dealer. Carter is approached by a stock promoter for Badger Company, who
offers to pay Carter additional compensation for sales of Badger Company's
stock to Carter's clients. Carter accepts the stock promoter's offer but does
not disclose the arrangements to his clients or to his employer. Carter sells
shares of the stock to his clients.
Comment: Carter has violated Standard VI(A) by failing to
disclose to clients that he is receiving additional compensation for
recommending and selling Badger stock. Because he did not disclose the
arrangement with Badger to his clients, the clients were unable to evaluate
whether Carter's recommendations to buy Badger were affected by this
arrangement. Carter's conduct also violated Standard VI(A) by failing to
disclose to his employer monetary compensation received in addition to the
compensation and benefits conferred by his employer. Carter was required by
Standard VI(A) to disclose the arrangement with Badger to his employer so that
his employer could evaluate whether the arrangement affected Carter's
objectivity and loyalty.
Example 6 (Conflict of Interest and Directorship)
Carol Corky, a senior portfolio manager for Universal
Management, recently became involved as a trustee with the Chelsea Foundation,
a large not-for-profit foundation in her hometown. Universal is a small money
manager (with assets under management of approximately USSI 00 million) that
caters to individual investors. Chelsea has assets in excess of USS2 billion.
Corky does not believe informing Universal of her involvement with Chelsea is
necessary.
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Comment: By failing to inform Universal of her involvement with Chelsea, Corky
violated Standard VI(A). Given the large size of the endowment at Chelsea,
Corky's new role as a trustee can reasonably be expected to be time consuming,
to the possible detriment of Corky's portfolio responsibilities with Universal.
Also, as a trustee, Corky may become involved in the investment decisions at
Chelsea. Therefore, Standard VI(A) obligates Corky to discuss becoming a
trustee at Chelsea with her compliance officer or supervisor at Universal
before accepting the position, and she should have disclosed the degree to
which she would be involved in investment decisions at Chelsea.
Example 7 (Conflict of Interest and Requested Favors)
Michael Papis is the chief investment officer of his state's
retirement fund. The fund has always used outside advisers for the real estate
allocation, and this information is clearly presented in all fund
communications. Thomas Nagle, a recognized sell-side research analyst and
Papis's business school classmate, recently left the investment bank he worked
for to start his own asset management firm, Accessible Real Estate. Nagle is
trying to build his assets under management and contacts Papis about gaining
some of the retirement fund's allocation. In the previous few years, the
performance of the retirement fund's real estate investments was in line with
the fund's benchmark but was not extraordinary. Papis decides to help out his
old friend and also to seek better returns by moving the real estate allocation
to Accessible. The only notice of the change in adviser appears in the next
annual report in the listing of associated advisers.
Comment: Papis has violated Standard VI(A) by not disclosing
to his employer his personal relationship with Nagle. Disclosure of his past
history with Nagle would allow his firm to determine whether the conflict may
have impaired Papis's independence in deciding to change managers.
|
See also Standard IV(C)—Responsibilities of Supervisors, Standard
V(A)—Diligence and Reasonable Basis, and Standard V(B)—Communication with
Clients and Prospective Clients.
|
Example 8
(Conflict of Interest and Business Relationships) Bob Wade, trust
manager for Central Midas Bank, was approached by Western Funds about
promoting its family of funds, with special interest in the service-fee
class. To entice Central to promote this class, Western Funds offered to pay
the bank a service fee of 0.25%. Without disclosing the fee being offered to
the bank, Wade asked one of the investment managers to review the Western
Funds family of funds to determine whether they were suitable for clients of
Central. The manager completed the normal due diligence review and determined
that the funds were fairly valued in the market with fee structures on a par
with their competitors. Wade decided to accept Western's offer and instructed
the team of portfolio managers to exclusively promote these funds and the
service-fee class to clients seeking to invest new funds or transfer from
their current investments. So as to not influence the investment managers,
Wade did not disclose the fee offer and allowed that income to flow directly
to the bank. Comment:
Wade is violating Standard VI(A) by not disclosing the portion of the service
fee being paid to Central. Although the investment managers may not be
influenced by the fee, neither they nor the client have the proper
information about Wade's decision to exclusively market this fund family and
class of investments. Central may come to rely on the new fee as a component
of the firm's profitability and may be unwilling to offer other products in
the future that could affect the fees received. (See also Standard |
Example 9 (Disclosure of Conflicts
to Employers)
Yehudit Dagan is a portfolio
manager for Risk Management Bank (RMB), whose clients include retirement plans
and corporations. RMB provides a defined contribution retirement plan for its
employees that offers 20 large diversified mutual fund investment options,
including a mutual fund managed by Dagan's RMB colleagues. After being employed
for six months, Dagan became eligible to participate in the retirement plan,
and she intends to allocate her retirement plan assets in six of the investment
options, including the fund managed by her RMB colleagues. Dagan is concerned
that joining the plan will lead to a potentially significant amount of
paperwork for her (e.g., disclosure of her retirement account holdings and
needing preclearance for her transactions), especially with her investing in
the in-house fund.
Comment:
Standard VI(A) would not require Dagan to disclosure her personal or retirement
investments in large diversified mutual funds, unless specifically required by
her employer. For practical reasons, the standard does not require Dagan to
gain preclearance for ongoing payroll deduction contributions to retirement
plan account investment options.
Dagan
should ensure that her firm does not have a specific policy regarding
investment— whether personal or in the retirement account—for funds managed by
the company's employees. These mutual funds may be subject to the company's
disclosure, preclearance, and trading restriction procedures to identify
possible conflicts prior to the execution of trades.
Standard VI(B) Priority
of Transactions
The Standard
Investment transactions
for clients and employers must have priority over investment transactions in
which a member or candidate is the beneficial owner.
Guidance
This standard is designed to
prevent any potential conflict of interest or the appearance of a conflict of
interest with respect to personal transactions.
Client interests have priority.
Client transactions must take precedence over transactions made on behalf of
the member's or candidate's firm or personal transactions.
Avoiding Potential
Conflicts
Although conflicts of interest
exist, nothing is inherently unethical about individual managers, advisers, or
mutual fund employees making money from personal investments as long as (l) the
client is not disadvantaged by the trade, (2) the investment professional does
not benefit personally from trades undertaken for clients, and (3) the
investment professional complies with applicable regulatory requirements.
|
Some situations occur in which a member or candidate may need to enter a
personal transaction that runs counter to current recommendations or what the
portfolio manager is doing for client portfolios. In these situations, the same
three criteria given in the preceding paragraph should be applied in the
transaction so as to not violate Standard VI(B).
Personal Trading Secondary
to frading for Clients
The objective of the standard is
to prevent personal transactions from adversely affecting the interests of clients
or employers. A member or candidate having the same investment positions or
being co-invested with clients does not always create a conflict.
Personal investment positions or
transactions of members or candidates or their firm should never, however, adversely
affect client investments.
Standards for Nonpublic
Information
Standard VI(B) covers the
activities of members and candidates who have knowledge of pending transactions
that may be made on behalf of their clients or employers, who have access to nonpublic
information during the normal preparation of research recommendations, or who
take investment actions. Members and candidates are prohibited from conveying
nonpublic information to any person whose relationship to the member or
candidate makes the member or candidate a beneficial owner of the person's
securities.
Members and candidates must not
convey this information to any other person if the nonpublic information can be
deemed material.
Impact on All Accounts
with Beneficial Ownership
Members or candidates may
undertake transactions in accounts for which they are a beneficial owner only
after their clients and employers have had adequate opportunity to act on a
recommendation.
Personal transactions include
those made for the member's or candidate's own account, for family (including
spouse, children, and other immediate family members) accounts, and for
accounts in which the member or candidate has a direct or indirect pecuniary
interest, such as a trust or retirement account. Family accounts that are client accounts should be treated
like any other firm account and should neither be given special treatment nor
be disadvantaged because of the family relationship. If a member or candidate
has a beneficial ownership in the account, however, the member or candidate may
be subject to preclearance or reporting requirements of the employer or
applicable law.
Recommended Procedures
for Compliance
Members and candidates should urge
their firms to establish such policies and procedures.
The specific provisions of each
firm's standards will vary, but all firms should adopt certain basic procedures
to address the conflict areas created by personal investing. These procedures
include the following:
Limited participation in equity IPOs. Restrictions on private placements. o
Establish blackout/restricted periods. o Reporting requirements, including:
Disclosure of holdings in which the
employee has a beneficial interest.
Providing duplicate confirmations
of transactions.
Preclearance procedures.
Disclosure of policies to
investors.
|
Application of the Standard
Example 1 (Personal Trading)
Research analyst Marlon Long does not recommend purchase of a
common stock for his employer's account because he wants to purchase the stock
personally and does not want to wait until the recommendation is approved and
the stock is purchased by his employer.
Comment: Long has violated Standard VI(B) by taking advantage
of his knowledge of the stock's value before allowing his employer to benefit
from that information.
Example
2 (frading for Family Member Account)
Carol Baker, the portfolio manager of an
aggressive growth mutual fund, maintains an account in her husband's name at
several brokerage firms with which the fund and a number of Baker's other
individual clients do a substantial amount of business. Whenever a hot issue
becomes available, she instructs the brokers to buy it for her husband's
account. Because such issues normally are scarce, Baker often acquires shares
in hot issues but her clients are not able to participate in them.
Comment:
To avoid violating Standard VI(B), Baker must acquire shares for her mutual
fund first and acquire them for her husband's account only after doing so, even
though she might miss out on participating in new issues via her husband's
account. She also must disclose the trading for her husband's account to her
employer because this activity creates a conflict between her personal
interests and her employer's interests.
|
Example 3 (Trading Prior
to Report Dissemination) A
brokerage's insurance analyst, Denise Wilson, makes a closed-circuit TV
report to her firm's branches around the country. During the broadcast, she
includes negative comments about a major company in the insurance industry.
The following day, Wilson's report is printed and distributed to the sales
force and public customers. The report recommends that both short-term
traders and intermediate investors take profits by selling that insurance
company's stock. Seven minutes after the broadcast, however, Ellen Riley,
head of the firm's trading department, had closed out a long "call"
position in the stock. Shortly thereafter, Riley established a sizable
"put" position in the stock. When asked about her activities, Riley
claimed she took the actions to facilitate anticipated sales by institutional
clients. Comment:
Riley did not give customers an opportunity to buy or sell in the options
market before the firm itself did. By taking action before the report was
disseminated, Riley's firm may have depressed the price of the calls and
increased the price of the puts. The firm could have avoided a conflict of
interest if it had waited to trade for its own account until its clients had
an opportunity to receive and assimilate Wilson's recommendations. As it is,
Riley's actions violated Standard VI(B). |
Standard VI(C) Re-feral
Fees
The Standard
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.
Guidance
Members and candidates must inform
their employer, clients, and prospective clients of any benefit received for
referrals of customers and clients.
|
Members and candidates must disclose when they pay a fee or provide
compensation to others who have referred prospective clients to the member or
candidate. Appropriate disclosure means that members and candidates must advise
the client or prospective client, before entry into any formal agreement for
seNices, of any benefit given or received for the recommendation of any
services provided by the member or candidate. In addition, the member or
candidate must disclose the nature of the consideration or benefit
Recommended Procedures for
Compliance
Members and candidates should
encourage their employers to develop procedures related to referral fees. The
firm may completely restrict such fees. If the firm does not adopt a strict
prohibition of such fees, the procedures should indicate the appropriate steps
for requesting approval.
Employers should have investment
professionals provide to the clients notification of approved referral fee
programs and provide the employer regular (at least quarterly) updates on the
amount and nature of compensation received.
Application of the
Standard
Example 1
(Disclosure of Interdepartmental Referral Arrangements)
James Handley works for the trust
department of Central Trust Bank. He receives compensation for each referral he
makes to Central Trust's brokerage department and personal financial management
department that results in a sale. He refers several of his clients to the
personal financial management department but does not disclose the arrangement
within Central Trust to his clients.
Comment: Handley has violated
Standard VIC) by not disclosing the referral arrangement at Central Trust Bank
to his clients. Standard VIC) does not distinguish between referral payments
paid by a third party for referring clients to the third party and internal
payments paid within the firm to attract new business to a subsidiary. Members
and candidates must disclose all such referral fees. Therefore, Handley is
required to disclose, at the time of referral, any referral fee agreement in
place among Central Trust Bank's departments. The disclosure should include the
nature and the value of the benefit and should be made in writing.
Example 2 (Disclosure of Referral
Arrangements and Informing Firm)
|
Katherine Roberts is a portfolio manager at Katama Investments, an advisory
firm specializing in managing assets for high-net-worth individuals. Katama's
trading desk uses a variety of brokerage houses to execute trades on behalf of
its clients. Roberts asks the trading desk to direct a large portion of its
commissions to Naushon, Inc., a small broker/dealer run by one of Roberts's
business school classmates. Katama's traders have found that Naushon is not
very competitive on pricing, and although Naushon generates some research for
its trading clients, Katama's other analysts have found most of Naushon's
research to be not especially useful. Nevertheless, the traders do as Roberts
asks, and in return for receiving a large portion of Katama's business, Naushon
recommends the investment services of Roberts and Katama to its wealthiest
clients. This arrangement is not disclosed to either Katama or the clients
referred by Naushon.
Comment: Roberts is violating
Standard VIC) by failing to inform her employer of the referral arrangement.
Example 3 (Disclosure of Referral Arrangements and Outside
Organizations)
Alex Burl is a portfolio manager at Helpful Investments, a
local investment advisory firm. Burl is on the advisory board of his child's
school, which is looking for ways to raise money to purchase new playground
equipment for the school. Burl discusses a plan with his supervisor in which he
will donate to the school a portion of his service fee from new clients
referred by the parents of students at the school. Upon getting the approval
from Helpful, Burl presents the idea to the school's advisory board and
directors. The school agrees to announce the program at the next parent event
and asks Burl to provide the appropriate written materials to be distributed. A
week following the distribution of the fliers, Burl receives the first
school-related referral. In establishing the client's investment policy
statement, Burl clearly discusses the school's referral and outlines the plans
for distributing the donation back to the school.
Comment: Burl has not violated Standard VI(C)
because he secured the permission of his employer, Helpful Investments, and the
school prior to beginning the program and because he discussed the arrangement
with the client at the time the investment policy statement was designed.
Example 4
(Disclosure of Referral Arrangements and Outside Parties)
The sponsor
of a state employee pension is seeking to hire a firm to manage the pension
plan's emerging market allocation. To assist in the review process, the sponsor
has hired Thomas Arrow as a consultant to solicit proposals from various
advisers. Arrow is contracted by the sponsor to represent its best interest in
selecting the most appropriate new manager. The process runs smoothly, and
Overseas Investments is selected as the new manager.
The
following year, news breaks that Arrow is under investigation by the local
regulator for accepting kickbacks from investment managers after they are
awarded new pension allocations. Overseas Investments is included in the list
of firms allegedly making these payments. Although the sponsor is happy with
the performance of Overseas since it has been managing the pension plan's
emerging market funds, the sponsor still decides to have an independent review
of the proposals and the selection process to ensure that Overseas was the
appropriate firm for its needs. This review confirms that, even though Arrow
was being paid by both parties, the recommendation of Overseas appeared to be
objective and appropriate.
Comment: Arrow has violated Standard VI(C) because he did not disclose the fee
being paid by Overseas. Withholding this information raises the question of a
potential lack of objectivity in the recommendations Overseas is making; this
aspect is in addition to questions about the legality of having firms pay to be
considered for an allocation.
Regulators and governmental agencies may adopt requirements
concerning allowable consultant activities. Local regulations sometimes include
having a consultant register with the regulatory agency's ethics board.
Regulator policies may include a prohibition on acceptance of payments from
investment managers receiving allocations and require regular reporting of
contributions made to political organizations and candidates. Arrow would have
to adhere to these requirements as well as the Code and Standards.
LESSON 7: STANDARD Vll:
RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE
Conduct As Participants in
the CFA Institute Program
B. Reference to CFA
Institute, the CFA Designation, and the CFA Program
Standard VII(A) Conduct
as Participants in CFA Institute Programs
The Standard
Members and candidates must not engage in any conduct that compromises
the reputation or integrity of CFA Institute or the CFA designation or the
integrity, validity, or security of CFA Institute programs.
Guidance
•
Standard VII(A) prohibits
any conduct that undermines the public's confidence that the CFA charter
represents a level of achievement based on merit and ethical conduct.
•
Conduct covered includes
but is not limited to:
•
Giving or receiving
assistance (cheating) on any CFA Institute examinations.
•
Violating the rules,
regulations, and testing policies of CFA Institute programs.
Providing confidential program or exam
information to candidates or the public.
•
Disregarding or attempting
to circumvent security measures established for any CFA Institute examinations.
Improperly using an association with CFA
Institute to further personal or professional goals.
•
Misrepresenting information
on the Professional Conduct Statement or in the CFA Institute Continuing
Education Program.
Confidential Program
Information 
Examples of information that cannot be disclosed by candidates
sitting for an exam include but are not limited to:
Specific details of questions appearing on the
exam.
•
Broad topical areas and
formulas tested or not tested on the exam. 
All aspects of the exam, including questions, broad topical
areas, and formulas, tested or not tested, are considered confidential until
such time as CFA Institute elects to release them publicly.
Additional CFA Program
Restrictions
•
Violating any of the testing policies, such as the calculator policy, personal
belongings policy, or the Candidate Pledge, constitutes a violation of Standard
VII(A).
•
Examples of information
that cannot be shared by members involved in developing, administering, or
grading the exams include but are not limited to: o Questions appearing on the
exam or under consideration.
Deliberation related to the exam process.
Information related to the scoring of
questions.
Expressing an Opinion
•
Standard VII(A) does not
cover expressing opinions regarding CFA Institute, the CFA Program, or other
CFA Institute programs.
•
However, when expressing a
personal opinion, a candidate is prohibited from disclosing content-specific
information, including any actual exam question and the information as to
subject matter covered or not covered in the exam.
Application of the
Standard
Example
1 (Sharing Exam Questions)
Travis
Nero serves as a proctor for the administration of the CFA examination in his
city. In the course of his ser,'ice, he reviews a copy of the Level Il exam on
the evening prior to the exam's administration and provides information
concerning the exam questions to two candidates who use it to prepare for the
exam.
Comment:
Nero and the two candidates have violated Standard VII(A). By giving
information about the exam questions to two candidates, Nero provided an unfair
advantage to the two candidates and undermined the integrity and validity of
the Level
Il exam as an accurate measure of the
knowledge, skills, and abilities necessary to earn the right to use the CFA
designation. By accepting the information, the candidates also compromised the
integrity and validity of the Level Il exam and undermined the ethical
framework that is a key part of the designation.
Example 2
(Sharing Exam Content)
After completing Level Il of the
CFA exam, Annabelle Rossi posts on her blog about her experience. She posts the
following: "Level Il is complete! I think I did fairly well on the exam.
It was really difficult, but fair. I think I did especially well on the
derivatives questions. And there were tons of them! I think I counted 18! The
ethics questions were really hard. I'm glad I spent so much time on the Code
and Standards. I was surprised to see there were no questions at all about IPO
allocations. I expected there to be a couple. Well, off to celebrate getting
through it. See you tonight?"
Comment: Rossi did not violate Standard VII(A) when she wrote about how
difficult she found the exam or how well she thinks she may have done. By
revealing portions of the CBOK covered on the exam and areas not covered,
however, she did violate Standard VII(A) and the Candidate Pledge. Depending on
the time frame in which the comments were posted, Rossi not only may have
assisted future candidates but also may have provided an unfair advantage to
candidates yet to sit for the same exam, thereby undermining the integrity and
validity of the Level Il exam.
The sponsor
of a state employee pension is seeking to hire a firm to manage the pension
plan's emerging market allocation. To assist in the review process, the sponsor
has hired Thomas Arrow as a consultant to solicit proposals from various
advisers. Arrow is contracted by the sponsor to represent its best interest in
selecting the most appropriate new manager. The process runs smoothly, and
Overseas Investments is selected as the new manager.
The
following year, news breaks that Arrow is under investigation by the local
regulator for accepting kickbacks from investment managers after they are
awarded new pension allocations. Overseas Investments is included in the list
of firms allegedly making these payments. Although the sponsor is happy with
the performance of Overseas since it has been managing the pension plan's
emerging market funds, the sponsor still decides to have an independent review
of the proposals and the selection process to ensure that Overseas was the
appropriate firm for its needs. This review confirms that, even though Arrow
was being paid by both parties, the recommendation of Overseas appeared to be
objective and appropriate.
|
Comment: Arrow has violated Standard VI(C) because he did not disclose the fee
being paid by Overseas. Withholding this information raises the question of a
potential lack of objectivity in the recommendations Overseas is making; this
aspect is in addition to questions about the legality of having firms pay to be
considered for an allocation.
Regulators and governmental agencies may adopt requirements
concerning allowable consultant activities. Local regulations sometimes include
having a consultant register with the regulatory agency's ethics board.
Regulator policies may include a prohibition on acceptance of payments from
investment managers receiving allocations and require regular reporting of
contributions made to political organizations and candidates. Arrow would have
to adhere to these requirements as well as the Code and Standards.
LESSON 7: STANDARD Vll:
RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE
Conduct As Participants in
the CFA Institute Program
B. Reference to CFA
Institute, the CFA Designation, and the CFA Program
Standard VII(A) Conduct
as Participants in CFA Institute Programs
The Standard
Members and candidates must not engage in any conduct that compromises
the reputation or integrity of CFA Institute or the CFA designation or the
integrity, validity, or security of CFA Institute programs.
Guidance
•
Standard VII(A) prohibits
any conduct that undermines the public's confidence that the CFA charter
represents a level of achievement based on merit and ethical conduct.
•
Conduct covered includes
but is not limited to:
•
Giving or receiving
assistance (cheating) on any CFA Institute examinations.
•
Violating the rules,
regulations, and testing policies of CFA Institute programs.
Providing confidential program or exam
information to candidates or the public.
•
Disregarding or attempting
to circumvent security measures established for any CFA Institute examinations.
Improperly using an association with CFA
Institute to further personal or professional goals.
•
Misrepresenting information
on the Professional Conduct Statement or in the CFA Institute Continuing
Education Program.
Confidential Program
Information Examples of information that cannot be disclosed by candidates
sitting for an exam include but are not limited to:
Specific details of questions appearing on the
exam.
•
Broad topical areas and
formulas tested or not tested on the exam. All aspects of the exam, including questions, broad topical
areas, and formulas, tested or not tested, are considered confidential until
such time as CFA Institute elects to release them publicly.
Additional CFA Program
Restrictions
•
|
Violating any of the testing policies, such as the calculator policy, personal
belongings policy, or the Candidate Pledge, constitutes a violation of Standard
VII(A).
•
Examples of information
that cannot be shared by members involved in developing, administering, or
grading the exams include but are not limited to: o Questions appearing on the
exam or under consideration.
Deliberation related to the exam process.
Information related to the scoring of
questions.
Expressing an Opinion
•
Standard VII(A) does not
cover expressing opinions regarding CFA Institute, the CFA Program, or other
CFA Institute programs.
•
However, when expressing a
personal opinion, a candidate is prohibited from disclosing content-specific
information, including any actual exam question and the information as to
subject matter covered or not covered in the exam.
Application of the
Standard
Example
1 (Sharing Exam Questions)
Travis
Nero serves as a proctor for the administration of the CFA examination in his
city. In the course of his ser,'ice, he reviews a copy of the Level Il exam on
the evening prior to the exam's administration and provides information
concerning the exam questions to two candidates who use it to prepare for the
exam.
Comment:
Nero and the two candidates have violated Standard VII(A). By giving
information about the exam questions to two candidates, Nero provided an unfair
advantage to the two candidates and undermined the integrity and validity of
the Level
Il exam as an accurate measure of the
knowledge, skills, and abilities necessary to earn the right to use the CFA
designation. By accepting the information, the candidates also compromised the
integrity and validity of the Level Il exam and undermined the ethical
framework that is a key part of the designation.
Example 2
(Sharing Exam Content)
After completing Level Il of the
CFA exam, Annabelle Rossi posts on her blog about her experience. She posts the
following: "Level Il is complete! I think I did fairly well on the exam.
It was really difficult, but fair. I think I did especially well on the
derivatives questions. And there were tons of them! I think I counted 18! The
ethics questions were really hard. I'm glad I spent so much time on the Code
and Standards. I was surprised to see there were no questions at all about IPO
allocations. I expected there to be a couple. Well, off to celebrate getting
through it. See you tonight?"
|
Comment: Rossi did not violate Standard VII(A) when she wrote about how
difficult she found the exam or how well she thinks she may have done. By
revealing portions of the CBOK covered on the exam and areas not covered,
however, she did violate Standard VII(A) and the Candidate Pledge. Depending on
the time frame in which the comments were posted, Rossi not only may have
assisted future candidates but also may have provided an unfair advantage to
candidates yet to sit for the same exam, thereby undermining the integrity and
validity of the Level Il exam.
Example
3 (Sharing Exam Content)
Level I candidate Etienne Gagne
has been a frequent visitor to an Internet forum designed specifically for CFA
Program candidates. The week after completing the Level I examination, Gagne
and several others begin a discussion thread on the forum about the most
challenging questions and attempt to determine the correct answers.
Comment: Gagne has violated
Standard VII(A) by providing and soliciting confidential exam information,
which compromises the integrity of the exam process and violates the Candidate
Pledge. In trying to determine correct answers to specific questions, the
group's discussion included question-specific details considered to be
confidential to the CFA Program.
Example 4 (Sharing Exam
Content)
CFA4Sure is
a company that produces test-preparation materials for CFA Program
candidates. Many candidates register for and use the company's products. The
day after the CFA examination, CFA4Sure sends an e-mail to all its customers
asking them to share with the company the hardest questions from the exam so
that CFA4Sure can better prepare its customers for the next exam
administration. Marisol Pena e-mails a summary of the questions she found
most difficult on the exam.
Comment: Pena has violated Standard VII(A) by
disclosing a portion of the exam questions. The information provided is
considered confidential until publicly released by
CFA Institute. CFA4Sure is likely to use such
feedback to refine its review materials for future candidates. Pena's sharing
of the specific questions undermines the integrity of the exam while
potentially making the exam easier for future candidates.
If the CFA4Sure employees who participated in
the solicitation of confidential CFA Program information are CFA Institute
members or candidates, they also have violated Standard VII(A).
Example 5 (Compromising CFA Institute Integrity as a
Volunteer)
Jose Ramirez is an investor-relations consultant for several
small companies that are seeking greater exposure to investors. He is also the
program chair for the CFA Institute society in the city where he works. Ramirez
schedules only companies that are his clients to make presentations to the
society and excludes other companies.
Comment:
Ramirez, by using his volunteer position at CFA Institute to benefit himself
and his clients, compromises the reputation and integrity of CFA Institute and
thus violates Standard VII(A).
Example 6 (Compromising CFA
Institute Integrity as a Volunteer)
Marguerite Warrenski is a member of the CFA Institute GIPS Executive Committee,
which oversees the creation, implementation, and revision of the GIPS
standards. As a member of the Executive Committee, she has advance knowledge of
confidential information regarding the GIPS standards, including any new or
revised standards the committee is considering. She tells her clients that her
Executive Committee membership will allow her to better assist her clients in
keeping up with changes to the Standards and facilitating their compliance with
the changes.
Comment: Warrenski is using her
association with the GIPS Executive Committee to promote her firm's services to
clients and potential clients. In defining her volunteer position at CFA
Institute as a strategic business advantage over competing firms and implying
to clients that she would use confidential information to further their
interests, Warrenski is compromising the reputation and integrity of CFA
Institute and thus violating Standard VII(A). She may factually state her
involvement with the Executive Committee but cannot imply any special advantage
to her clients from such participation.
Standard VII(B) Reference
to CFA Institute, the CFA Designation, and the CFA Program
The Standard
When referring to CFA
Institute, CFA Institute membership, the CFA designation, or candidacy in the
CFA Program, members and candidates must not misrepresent or exaggerate the
meaning or implications of membership in CFA Institute, holding the CFA designation,
or candidacy in the CFA Program.
Guidance
•
Standard VII(B) is intended
to prevent promotional efforts that make promises or guarantees that are tied
to the CFA designation. Individuals may refer to their CFA
©
designation, CFA Institute membership, or candidacy in the CFA Program
but must not exaggerate the meaning or implications of membership in CFA
Institute, holding the CFA designation, or candidacy in the CFA Program.
•
Standard VII(B) is not
intended to prohibit factual statements related to the positive benefit of
earning the CFA designation. However, statements referring to CFA Institute,
the CFA designation, or the CFA Program that overstate the competency of an
individual or imply, either directly or indirectly, that superior performance
can be expected from someone with the CFA designation are not allowed under the
standard. 
Statements that highlight or emphasize the commitment of
CFA Institute members, CFA charterholders, and CFA candidates to ethical and
professional conduct or mention the thoroughness and rigor of the CFA Program
are appropriate.
•
Members and candidates may
make claims about the relative merits of CFA Institute, the CFA Program, or the
Code and Standards as long as those statements are implicitly or explicitly
stated as the opinion of the speaker.
•
Standard VII(B) applies to
any form of communication, including but not limited to communications made in
electronic or written form (such as on firm letterhead, business cards,
professional biographies, directory listings, printed advertising, firm brochures,
or personal resumes), and oral statements made to the public, clients, or
prospects.
CFA Institute Membership
The term "CFA
Institute member" refers to "regular" and "affiliate"
members of CFA
Institute who have met
the membership requirements as defined in the CFA Institute Bylaws. Once
accepted as a CFA Institute member, the member must satisfy the following
requirements to maintain his or her status:
•
Remit annually to CFA Institute a completed Professional Conduct Statement,
which renews the commitment to abide by the requirements of the Code and
Standards and the CFA Institute Professional Conduct Program.
•
Pay applicable CFA
Institute membership dues on an annual basis.
If a CFA Institute member
fails to meet any of these requirements, the individual is no longer considered
an active member. Until membership is reactivated, individuals must not present
themselves to others as active members. They may state, however, that they were
CFA Institute members in
the past or refer to the years when their membership was active.
Using the CFA Designation
•
Those who have earned the
right to use the Chartered Financial Analyst designation may use the trademarks
or registered marks "Chartered Financial Analyst" or "CFA"
and are encouraged to do so but only in a manner that does not misrepresent or
exaggerate the meaning or implications of the designation.
•
The use of the designation
may be accompanied by an accurate explanation of the requirements that have
been met to earn the right to use the designation.
•
"CFA
charterholders" are those individuals who have earned the right to use the
CFA designation granted by CFA Institute. These people have satisfied certain
requirements, including completion of the CFA Program and required years of
acceptable work experience. Once granted the right to use the designation,
individuals must also satisfy the CFA Institute membership requirements (see
above) to maintain their right to use the designation.
•
If a CFA charterholder
fails to meet any of the membership requirements, he or she forfeits the right
to use the CFA designation. Until membership is reactivated, individuals must
not present themselves to others as CFA charterholders. They may state,
however, that they were charterholders in the past.
•
Given the growing popularity
of social media, where individuals may anonymously express their opinions,
pseudonyms or online profile names created to hide a member's identity should
not be tagged with the CFA designation.
•
Use of the CFA designation
by a CFA charterholder is governed by the terms and conditions of the annual
Professional Conduct Statement Agreement, entered into between CFA Institute
and its membership prior to commencement of use of the CFA designation and
reaffirmed annually.
Referring to Candidacy in
the CFA Program
•
Candidates in the CFA
Program may refer to their participation in the CFA Program, but such
references must clearly state that an individual is a candidate in the CFA
Program and must not imply that the candidate has achieved any type of partial designation.
A person is a candidate in the CFA Program if:
The person's application for registration in
the CFA Program has been accepted by CFA Institute, as evidenced by issuance of
a notice of acceptance, and the person is enrolled to sit for a specified
examination; or 
The registered person has sat for a specified
examination but exam results have not yet been received.
•
If an individual is
registered for the CFA Program but declines to sit for an exam or otherwise
does not meet the definition of a candidate as described in the CFA Institute
Bylaws, then that individual is no longer considered an active candidate. Once
the person is enrolled to sit for a future examination, his or her CFA
candidacy resumes.
•
CFA candidates must never state or imply that they have a partial designation
as a result of passing one or more levels, or cite an expected completion date
of any level of the CFA Program. Final award of the charter is subject to
meeting the CFA Program requirements and approval by the CFA Institute Board of
Governors. 
If a candidate passes each level of the exam
in consecutive years and wants to state that he or she did so, that is not a
violation of Standard VII(B) because it is a statement of fact. If the
candidate then goes on to claim or imply superior ability by obtaining the
designation in only three years, however, he or she is in violation of Standard
VII(B).
Proper and Improper
References to the CFA Designation
Proper References Improper
References
Level I candidate Etienne Gagne
has been a frequent visitor to an Internet forum designed specifically for CFA
Program candidates. The week after completing the Level I examination, Gagne
and several others begin a discussion thread on the forum about the most
challenging questions and attempt to determine the correct answers.
Comment: Gagne has violated
Standard VII(A) by providing and soliciting confidential exam information,
which compromises the integrity of the exam process and violates the Candidate
Pledge. In trying to determine correct answers to specific questions, the
group's discussion included question-specific details considered to be
confidential to the CFA Program.
|
Example 4 (Sharing Exam
Content) CFA4Sure is
a company that produces test-preparation materials for CFA Program
candidates. Many candidates register for and use the company's products. The
day after the CFA examination, CFA4Sure sends an e-mail to all its customers
asking them to share with the company the hardest questions from the exam so
that CFA4Sure can better prepare its customers for the next exam
administration. Marisol Pena e-mails a summary of the questions she found
most difficult on the exam. Comment: Pena has violated Standard VII(A) by
disclosing a portion of the exam questions. The information provided is
considered confidential until publicly released by |
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CFA Institute. CFA4Sure is likely to use such
feedback to refine its review materials for future candidates. Pena's sharing
of the specific questions undermines the integrity of the exam while
potentially making the exam easier for future candidates.
If the CFA4Sure employees who participated in
the solicitation of confidential CFA Program information are CFA Institute
members or candidates, they also have violated Standard VII(A).
Example 5 (Compromising CFA Institute Integrity as a
Volunteer)
Jose Ramirez is an investor-relations consultant for several
small companies that are seeking greater exposure to investors. He is also the
program chair for the CFA Institute society in the city where he works. Ramirez
schedules only companies that are his clients to make presentations to the
society and excludes other companies.
Comment:
Ramirez, by using his volunteer position at CFA Institute to benefit himself
and his clients, compromises the reputation and integrity of CFA Institute and
thus violates Standard VII(A).
Example 6 (Compromising CFA
Institute Integrity as a Volunteer)
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Marguerite Warrenski is a member of the CFA Institute GIPS Executive Committee,
which oversees the creation, implementation, and revision of the GIPS
standards. As a member of the Executive Committee, she has advance knowledge of
confidential information regarding the GIPS standards, including any new or
revised standards the committee is considering. She tells her clients that her
Executive Committee membership will allow her to better assist her clients in
keeping up with changes to the Standards and facilitating their compliance with
the changes.
Comment: Warrenski is using her
association with the GIPS Executive Committee to promote her firm's services to
clients and potential clients. In defining her volunteer position at CFA
Institute as a strategic business advantage over competing firms and implying
to clients that she would use confidential information to further their
interests, Warrenski is compromising the reputation and integrity of CFA
Institute and thus violating Standard VII(A). She may factually state her
involvement with the Executive Committee but cannot imply any special advantage
to her clients from such participation.
Standard VII(B) Reference
to CFA Institute, the CFA Designation, and the CFA Program
The Standard
When referring to CFA
Institute, CFA Institute membership, the CFA designation, or candidacy in the
CFA Program, members and candidates must not misrepresent or exaggerate the
meaning or implications of membership in CFA Institute, holding the CFA designation,
or candidacy in the CFA Program.
Guidance
•
Standard VII(B) is intended
to prevent promotional efforts that make promises or guarantees that are tied
to the CFA designation. Individuals may refer to their CFA
©
designation, CFA Institute membership, or candidacy in the CFA Program
but must not exaggerate the meaning or implications of membership in CFA
Institute, holding the CFA designation, or candidacy in the CFA Program.
•
Standard VII(B) is not
intended to prohibit factual statements related to the positive benefit of
earning the CFA designation. However, statements referring to CFA Institute,
the CFA designation, or the CFA Program that overstate the competency of an
individual or imply, either directly or indirectly, that superior performance
can be expected from someone with the CFA designation are not allowed under the
standard. Statements that highlight or emphasize the commitment of
CFA Institute members, CFA charterholders, and CFA candidates to ethical and
professional conduct or mention the thoroughness and rigor of the CFA Program
are appropriate.
•
Members and candidates may
make claims about the relative merits of CFA Institute, the CFA Program, or the
Code and Standards as long as those statements are implicitly or explicitly
stated as the opinion of the speaker.
•
Standard VII(B) applies to
any form of communication, including but not limited to communications made in
electronic or written form (such as on firm letterhead, business cards,
professional biographies, directory listings, printed advertising, firm brochures,
or personal resumes), and oral statements made to the public, clients, or
prospects.
CFA Institute Membership
The term "CFA
Institute member" refers to "regular" and "affiliate"
members of CFA
Institute who have met
the membership requirements as defined in the CFA Institute Bylaws. Once
accepted as a CFA Institute member, the member must satisfy the following
requirements to maintain his or her status:
•
|
Remit annually to CFA Institute a completed Professional Conduct Statement,
which renews the commitment to abide by the requirements of the Code and
Standards and the CFA Institute Professional Conduct Program.
•
Pay applicable CFA
Institute membership dues on an annual basis.
If a CFA Institute member
fails to meet any of these requirements, the individual is no longer considered
an active member. Until membership is reactivated, individuals must not present
themselves to others as active members. They may state, however, that they were
CFA Institute members in
the past or refer to the years when their membership was active.
Using the CFA Designation
•
Those who have earned the
right to use the Chartered Financial Analyst designation may use the trademarks
or registered marks "Chartered Financial Analyst" or "CFA"
and are encouraged to do so but only in a manner that does not misrepresent or
exaggerate the meaning or implications of the designation.
•
The use of the designation
may be accompanied by an accurate explanation of the requirements that have
been met to earn the right to use the designation.
•
"CFA
charterholders" are those individuals who have earned the right to use the
CFA designation granted by CFA Institute. These people have satisfied certain
requirements, including completion of the CFA Program and required years of
acceptable work experience. Once granted the right to use the designation,
individuals must also satisfy the CFA Institute membership requirements (see
above) to maintain their right to use the designation.
•
If a CFA charterholder
fails to meet any of the membership requirements, he or she forfeits the right
to use the CFA designation. Until membership is reactivated, individuals must
not present themselves to others as CFA charterholders. They may state,
however, that they were charterholders in the past.
•
Given the growing popularity
of social media, where individuals may anonymously express their opinions,
pseudonyms or online profile names created to hide a member's identity should
not be tagged with the CFA designation.
•
Use of the CFA designation
by a CFA charterholder is governed by the terms and conditions of the annual
Professional Conduct Statement Agreement, entered into between CFA Institute
and its membership prior to commencement of use of the CFA designation and
reaffirmed annually.
Referring to Candidacy in
the CFA Program
•
Candidates in the CFA
Program may refer to their participation in the CFA Program, but such
references must clearly state that an individual is a candidate in the CFA
Program and must not imply that the candidate has achieved any type of partial designation.
A person is a candidate in the CFA Program if:
The person's application for registration in
the CFA Program has been accepted by CFA Institute, as evidenced by issuance of
a notice of acceptance, and the person is enrolled to sit for a specified
examination; or The registered person has sat for a specified
examination but exam results have not yet been received.
•
If an individual is
registered for the CFA Program but declines to sit for an exam or otherwise
does not meet the definition of a candidate as described in the CFA Institute
Bylaws, then that individual is no longer considered an active candidate. Once
the person is enrolled to sit for a future examination, his or her CFA
candidacy resumes.
•
|
CFA candidates must never state or imply that they have a partial designation
as a result of passing one or more levels, or cite an expected completion date
of any level of the CFA Program. Final award of the charter is subject to
meeting the CFA Program requirements and approval by the CFA Institute Board of
Governors. If a candidate passes each level of the exam
in consecutive years and wants to state that he or she did so, that is not a
violation of Standard VII(B) because it is a statement of fact. If the
candidate then goes on to claim or imply superior ability by obtaining the
designation in only three years, however, he or she is in violation of Standard
VII(B).
Proper and Improper
References to the CFA Designation
Proper References Improper
References
"Completion of the
CFA Program has enhanced my portfolio management skills."
"John Smith passed
all three CFA Program examinations in three consecutive years."
"The CFA designation
is globally recognized and attests to a charterholder's success in a rigorous
and comprehensive study program in the field of investment management and
research analysis."
"The credibility that the CFA designation affords and the skills the CFA
Program cultivates are key assets for my future career development."
"CFA charterholders achieve better performance results."
"John Smith is among the elite, having passed all three CFA
examinations in three consecutive attempts."
"As a CFA
charterholder, I am the most qualified to manage client investments."
"As a CFA
charterholder, Jane White provides the best value in trade execution."
|
Proper References |
Improper References |
|
"I enrolled in the CFA Program
to obtain the highest set of credentials in the global investment management
industry." "I passed Level I of the CFA
Program." "I am a 2010 Level Ill candidate in
the CFA Program "I passed
all three levels of the CFA Program and will be eligible for the CFA charter
upon completion of the required work experience." |
"Enrolling
as a candidate in the CFA Program ensures one of becoming better at valuing
debt securities." "CFA, Level 11" "CFA, Expected 2011 ' "Level
111 CFA Candidate" "CFA, Expected 2011 " "John Smith, Charter Pending" |
Application of the Standard
Example 1 (Passing Exams in Consecutive Years)
An advertisement for AZ Investment Advisors states that all
the firm's principals are CFA charterholders and all passed the three
examinations on their first attempt. The advertisement prominently links this fact
to the notion that AZ's mutual funds have achieved superior performance.
 |
Comment: AZ may state that all principals passed the three examinations on the
first try as long as this statement is true, but it must not be linked to
performance or imply superior ability. Implying that (l) CFA charterholders
achieve better investment results and (2) those who pass the exams on the first
try may be more successful than those who do not violates Standard VII(B).
Example 2 (Right to Use CFA Designation)
Five years after receiving his CFA charter, Louis Vasseur
resigns his position as an investment analyst and spends the next two years
traveling abroad. Because he is not actively engaged in the investment
profession, he does not file a completed Professional Conduct Statement with
CFA Institute and does not pay his CFA Institute membership dues. At the
conclusion of his travels, Vasseur becomes a self-employed analyst accepting
assignments as an independent contractor. Without reinstating his CFA Institute
membership by filing his Professional Conduct Statement and paying his dues, he
prints business cards that display "CFA" after his name.
Comment: Vasseur has violated Standard VII(B) because his
right to use the CFA designation was suspended when he failed to file his
Professional Conduct Statement and stopped paying dues. Therefore, he no longer
is able to state or imply that he is an active CFA charterholder. When Vasseur
files his Professional Conduct Statement, resumes paying CFA Institute dues to
activate his membership, and completes the CFA Institute reinstatement
procedures, he will be eligible to use the CFA designation.
Example 3 (Order of Professional
and Academic Designations)
 |
Tatiana Prittima has earned both her CFA designation and a PhD in finance. She
would like to cite both her accomplishments on her business card but is unsure
of the proper method for doing so.
Comment: The order of designations
cited on such items as resumes and business cards is a matter of personal
preference. Prittima is free to cite the CFA designation either before or after
citing her PhD.
|
Example 4
(Use of Fictitious Name) Barry Glass is the lead quantitative
analyst at CityCenter Hedge Fund. Glass is responsible for the development,
maintenance, and enhancement of the proprietary models the fund uses to
manage its investors' assets. Glass reads several high-level mathematical
publications and blogs to stay informed on current developments. One blog,
run by Expert CFA, presents some intriguing research that may benefit one of
CityCenter's current models. Glass is under pressure from firm executives to
improve the model's predictive abilities, and he incorporates the factors
discussed in the online research. The updated output recommends several new
investments to the fund's portfolio managers. Comment: "Expert CFA" has violated
Standard VII(B) by using the CFA designation inappropriately. As with any
research report, authorship of online comments must include the
charterholder's full name along with any reference to the CFA designation. See also Standard V(A)—Diligence and Reasonable Basis, which Glass
has violated for guidance on diligence and reasonable basis. |
INTRODUCTION
TO THE GLOBAL INVESTMENT PERFORMANCE STANDARDS (GIPS)
READING 4'. INTRODUCTION
TO THE GLOBAL INVESTMENT
PERFORMANCE STANDARDS
(GIPS)
LESSON 1:
INTRODUCTION TO THE GLOBAL INVESTMENT PERFORMANCE STANDARDS (GIPS)
LOS 4a: Explain why the GIPS standards were created,
what parties the GIPS standards apply to, and who is served by the standards.
vol 1, pp 227-229
Individual and
institutional investors typically use past investment performance to gauge a
fund manager's ability, and to make investment decisions. Questions relating to
the accuracy and credibility of the data used in investment performance
presentation make comparisons difficult. Other misleading practices that have
been common in performance presentation include:
Representative
accounts: Use of only the best performing portfolios to represent the firm's
overall performance.
Survivorship bias:
Historical data relating to investment performance excludes the performance of
those accounts that faired poorly and were consequently terminated. This
results in an overstatement of investment performance.
 |
Varying time periods: Presenting performance relating only to those time
periods during which the fund outperformed its benchmark or had exceptional
performance.
The GIPS
standards aim to provide clients and prospective clients with comparable and
representative investment performance data. They establish an industry-wide,
standard approach for calculation and presentation of investment performance.
This forces complying firms to avoid misrepresentation and to communicate all
relevant information that prospective clients should know to make informed
investment decisions.
Who Can Claim Compliance?
Compliance with
GIPS standards for any firm is voluntary and not required by any legal or
regulatory authorities. However, only investment management firms that actually
manage assets can claim compliance. Plan sponsors and consultants cannot claim
to comply with GIPS if they do not manage any assets. They can only endorse the
standards or require their investment managers to comply with them. Further,
compliance is a firm-wide process that cannot be achieved on a single product
or composite. In order to claim compliance, the firm needs to comply with all
requirements of GIPS standards; there is no such thing as partial compliance to
GIPS.
Who Benefits from
Compliance?
The GIPS standards
benefit two main groups—investment management firms and prospective clients.
Compliance with GIPS assures
clients that the historical records presented by a firm are both complete and
fairly presented so it helps investment management firms in their marketing
activities. Further, compliance with GIPS may also strengthen the firm's
internal controls.
2. Investors are provided with credible data
for different investment firms and can therefore, easily compare firms'
performance to make an informed decision regarding the selection of investment
managers.
LOS 4b: Explain the construction and purpose of composites in
performance reporting. Vol 1, pg 229
The GIPS standards
require the use of composites. A composite is formed by combining discretionary
portfolios into one group that represents a particular investment objective or
strategy. A composite representing a particular strategy must include all discretionary
portfolios managed according to that strategy.
To ensure that the firm
does not include only its best performing funds when presenting its investment
performance, GIPS standards require that the criteria for classifying
portfolios into composites are decided before performance is known (i.e., on an
ex-ante basis), not after the fact.
LOS "c: Explain the requirements for verification. vol 1,
pp 229-230
Firms that claim
compliance with GIPS standards are responsible for ensuring that they really
are compliant and maintaining their compliant status going forward. After
claiming compliance, firms may hire an independent third party to verify that
they are compliant to add credibility to their claim. Verification may also
increase the knowledge of the firm's performance measurement team and improve
the consistency and quality of the firm's compliant presentations.
 |
Verification assures that the investment manager is compliant with GIPS
standards on a firm-wide basis. Verification needs to be performed on the
entire firm rather than specific composites. Verification tests:
Whether the investment firm has
complied with all the composite construction requirements on a firm-wide basis;
and
Whether the firm's processes and
procedures calculate and present performance information according to GIPS
standards.
Verification is optional,
and it cannot be performed by the firm itself.
The Structure of the GIPS
Standards
The provisions within the
2010 edition of the GIPS standards are divided into the following nine
sections:
0 Fundamentals of
Compliance
Input Data
2
Calculation Methodology
3
Composite Construction
4
Disclosure
5
Presentation and Reporting
6
Real Estate
7
Private Equity
8
Wrap Fee/Separately Managed
Account (SMA) Portfolios
These provisions are
further divided into requirements and recommendations.
THE
GIPS STANDARDS
READING 5: THE GIPS
STANDARDS
LESSON 1: GLOBAL
INVESTMENT PERFORMANCE STANDARDS (GIPS)
LOS 5a: Describe the key features of the GIPS standards
and the fundamentals of compliance.vol 1, pp 235-237, 241-242
Financial markets around the world have become more
integrated in recent years. With the dynamic growth in assets under management
for investment companies, prospective clients and investors require a
consistent standard for performance measurement and presentation, so that they
can make well-informed decisions when choosing an investment manager to manage
their assets.
Investment
managers who adhere to investment performance standards help assure investors
that the firm's investment performance is complete and fairly presented.
Further, by adhering to a global standard, firms in countries with minimal or
no investment performance standards will be able to compete for business on an
equal footing with firms from countries with more developed standards.
Objectives of GIPS
 |
To establish investment industry best practices for calculating and presenting
investment performance that promote investor interests and instill investor
confidence.
To obtain worldwide acceptance of
a single standard for the calculation and presentation of investment
performance based on the principles of fair representation and full disclosure.
To promote the use of accurate and
consistent investment performance data. 
To encourage fair, global competition among investment firms
without creating barriers to entry.
To foster the notion of industry
"self-regulation" on a global basis.
Overview
GIPS standards have the
following key features:
GIPS standards are ethical
standards to ensure full disclosure and fair representation of investment
performance. In order to claim compliance, firms must adhere to all the
requirements of the GIPS standards.
Apart from adhering to the minimum
requirements of the GIPS standards, firms should try to adhere to the
recommendations of the GIPS standards to achieve best practice in the
calculation and presentation of performance.
Firms should include all actual,
discretionary, fee-paying portfolios in at least one composite defined by
investment mandate, objective, or strategy in order to prevent firms from
cherry-picking their best performance.
The accuracy of performance
presentation is dependent on the accuracy of input data. The underlying
valuations of portfolio holdings drive the portfolio's performance. Therefore,
it is essential for these and other inputs to be accurate. The GIPS standards
require firms to adhere to certain calculation methodologies and to make
specific disclosures along with the firm's performance.
THE GIPS STANDARDS
Firms must comply with all
requirements of the GIPS standards, including any updates, Guidance Statements,
interpretations, Questions & Answers, and clarifications published by CFA
Institute and the GIPS Executive Committee, which are available on the GIPS
website as well as in the GIPS Handbook.
The GIPS standards do not
address every aspect of performance measurement or cover unique characteristics
of each asset class. However, they will continue to evolve over time to address
additional areas of investment performance.
Fundamentals of
Compliance
The fundamentals of
compliance include both recommendations and requirements.
Requirements
Firms must comply with all the
requirements of the GIPS standards, including any updates, Guidance Statements,
interpretations, Questions & Answers, and clarifications published by CFA
Institute and the GIPS Executive Committee, which are available on the GIPS
website as well as in the GIPS Handbook. 
Firms must comply with all applicable laws and regulations regarding
the calculation and presentation of performance.
Firms must not present performance
or performance-related information that is false or misleading.
The GIPS standards must be applied
on a firm-wide basis.
 |
Firms must document their policies and procedures used in establishing and
maintaining compliance with the GIPS standards, including ensuring the
existence and ownership of client assets, and must apply them consistently.
If the firm does not meet all the
requirements of the GIPS standards, it must not represent or state that it is
"in compliance with the Global Investment Performance Standards except for
. or make any other statements that may indicate partial compliance with the
GIPS standards.
Statements referring to the
calculation methodology as being "in accordance," "in
compliance," or "consistent with" the GIPS standards, or similar
statements, are prohibited.
Statements referring to the
performance of a single, existing client portfolio as being "calculated in
accordance with the GIPS standards" are prohibited, except when a
GIPS-compliant firm reports the performance of an individual client's portfolio
to that particular client.
Firms must make every reasonable
effort to provide a compliant presentation to all prospective clients. Firms
must not choose whom they present a compliant presentation to. As long as a
prospective client has received a compliant presentation within the previous 12
months, the firm has met this requirement. 
Firms must provide a complete list of composite descriptions to any
prospective client that makes such a request. They must include terminated
composites on their list of composite descriptions for at least five years
after the composite termination date.
Firms must provide a compliant
presentation for any composite listed on their list of composite descriptions
to any prospective client that makes such a request. 
Firms must be defined as an investment firm, subsidiary, or
division held out to clients or prospective clients as a distinct business
entity.
For periods beginning on or after
January l , 201 1, total firm assets must be aggregate fair value of all discretionary
and non-discretionary assets managed by the firm. This includes both fee-paying
and non-fee-paying portfolios.
THE
GIPS STANDARDS
Total firm assets must include
assets assigned to a sub-advisor, provided that the firm has discretion over
the selection of the sub-advisor.
Changes in a firm's organization
must not lead to alteration of historical composite performance.
When the firm jointly markets with
other firms, the firm claiming compliance with the GIPS standards must ensure
that it is clearly defined and separate from the other firms being marketed,
and that it is clear which firm is claiming compliance.
Recommendations
Firms should comply with the
recommendations of the GIPS standards, including recommendations in any
updates, Guidance Statements, interpretations, Questions & Answers, and
clarifications published by CFA Institute and the GIPS Executive Committee,
which will be made available on the GIPS website as well as in the
GIPS Handbook.
Firms should be verified.
Firms should adopt the broadest,
most meaningful definition of the firm, encompassing all geographical offices
operating under the same brand name regardless of the actual name of the
individual investment management company. 
Firms should provide to each existing client, on an annual basis, a
compliant presentation of the composite in which the client's portfolio is
included.
|
LOS
5b: Describe the scope of the GIPS standards with respect to an investment
firm's definition and historical performance record.vol 1, pp 236-237
Compliance with
GIPS standards facilitates an investment firm participation in the global
investment management industry. To claim compliance, investment management
firms must define an entity that claims compliance (the firm). This firm must
be defined as an investment firm, subsidiary or a division held out to clients
and prospects as a "distinct business entity."
Firms are required to present a minimum of five years of
GIPS-compliant historical investment performance. If the firm or composite has
been in existence for less than five years, the presentation should include
performance since inception. After initiating compliance with GIPS standards,
the firm must add one year of compliant performance each year, so that the firm
eventually presents a (minimum) performance record for 10 years.
Firms may link
non-GIPS-compliant performance records to their compliant history as long as
the non-compliant record is not for data after January l, 2000. In such a case
the firm must disclose the period of non-compliant data and disclose how the
performance presentation differs from GIPS standards.
Firms that manage
private equity, real estate, and/or wrap fee/separately managed account (SMA)
portfolios must also comply with Sections 6, 7, and 8, respectively, of the Provisions
of the GIPS standards that became effective as of January 1, 2006.
The effective date
for the 2010 edition of the GIPS standards is I January 201 1. Compliant
presentations that include performance for periods that begin on or after
January 1, 201 1 must be prepared in accordance with the 2010 edition of the
GIPS standards. Prior editions of the GIPS standards may be found on the GIPS
website.
THE GIPS STANDARDS
LOS 5c: Explain how the GIPS standards are implemented in
countries with existing standards for performance reporting and describe the
appropriate response when the GIPS standards and local regulations conflict.
vol 1, pp 237-238
The GIPS Executive Committee
strongly encourages countries without an investment performance standard to
promote the GIPS standards as the local standard and translate them into the
local language when necessary.
Local sponsoring
organizations provide an important link between the GIPS Executive Committee,
the governing body for the GIPS standards, and the local markets in which
investment managers operate.
In countries where laws
and regulations regarding performance presentation do exist, firms are
encouraged to adhere to GIPS in addition to their local laws. In case of a
conflict, local laws are applicable and firms are required to disclose the
conflict.
LOS 5d: Describe the nine major sections of the GIPS
standards. vol 1, pp 239-241
 |
The nine major sections of the GIPS standards are:
O. Fundamentals of compliance which
discusses issues pertaining to definition of a firm, documentation of policies
and procedures, maintaining compliance with any updates and ensuring proper
reference to claim of compliance with GIPS and references to verification of
GIPS.
Input data which specifies
standards for input data to be used to calculate investment performance. For
periods beginning on or after January 1 , 2011 , all portfolios must be valued
in accordance with the definition of fair value and the GIPS Valuation Principles.
2.
Calculation methodology includes
definitions of specific methods for return calculations of portfolios and
composites.
3.
Composite construction: Composites
should be constructed to achieve consistency and fair presentation. Details
were discussed in LOS 4b.
4.
Disclosures Requirements for
disclosure of information pertaining to a firm's policies and performance
presentation.
5.
Presentation and reporting:
Performance presentation must be according to GIPS requirements.
6.
Real estate standards must be
applied to present performance relating to real estate investments.
7.
Private equity: GIPS Private
Equity Valuation Principles must be used to value private equity investments,
except for open-end and evergreen funds.
8.
Wrap Fee/Separately Managed
Account (SMA) Portfolios: Firms must include the performance record of all wrap
fee/SMA portfolios in appropriate composites in accordance with the firm's
established portfolio inclusion policies.
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