Portfolio Theory & Behavioural Finance Lecture Slides PDF

Portfolio Theory & Behavioral Finance (w.IN.20HS.V) Block 6: Ethics in Finance Building Competence. Crossing Borders. Dr.-Ing. Martin Schnauss, CFA, FRM / Laura Archer-Svoboda [email protected], [email protected] / Vers. 1.4 Topics  Introduction: Ethics in...

Portfolio Theory & Behavioral Finance (w.IN.20HS.V) Block 6: Ethics in Finance Building Competence. Crossing Borders. Dr.-Ing. Martin Schnauss, CFA, FRM / Laura Archer-Svoboda [email protected], [email protected] / Vers. 1.4 Topics  Introduction: Ethics in Finance  CFA Institute Ethical Decision-making Framework  Code of Ethics  Standards of Professional Conduct: Ethical responsibilities 1. Professionalism 2. Integrity of Capital Markets 3. Duties to Clients 4. Duties to Employers 5. Investment Analysis, Recommendations, and Actions 6. Conflicts of Interest 7. (Responsibilities as a CFA Institute member or CFA Candidate)  GIPS: Global Investment Performance Standards 2 Introduction: Ethics in Finance Ethical Behavior & Ethical Standards in Finance Sources: CFA Institute, www.cfainstitute.org Kaplan Schweser, www.schweser.com/ 3 Introduction: Ethics in Finance Ethics Definition Ethics are a set of moral principles or rules of conduct that provide guidance for our behavior when it affects others. Fundamental ethical principles include honesty, fairness, diligence, and care and respect for others Source: CFA (2014), Standards of Practice Handbook 4 Introduction: Ethics in Finance Challenges in Ethical Behavior Overestimating one's own ethical character Considering only near-term consequences and neglecting longer- term consequences of behavior Allowing situational (external) influence to unduly affect one's decisions and behavior. ex. peer pressure OR Complete disregard of ethical standards 5 Introduction: Ethics in Finance Need for high ethical standards in the investment industry Investment professionals have a responsibility to use their specialized knowledge and skills to both protect and grow client assets Asymmetry Investment management is an intangible product makes high ethical standards all the more important in the financial services profession 6 Introduction: Ethics in Finance Ethical vs. Legal Standards Not all unethical actions are illegal, and not all illegal actions are unethical. Laws are more specific than ethical principles and often address prior unethical behavior. Ethical behavior requires more judgment; acts such as civil disobedience may be considered ethical even when they are illegal 7 CFA Institute Ethical Decision-making Framework A tool for analyzing and evaluating ethical scenarios in the investment CFA Institute Ethical Decision-making Framework profession A decision-making structure for situations that fall outside the clear confines of ‘right’ and ‘wrong’. Provides a summary of the key elements of making ethical decisions Keep in mind: there will likely be additional influences, conflicts, and actions unique to each ethical scenario and beyond those detailed in the framework 8 CFA Institute Code of Ethics and Standards of Professional Conduct Purpose: to ensure ethical behavior, professional integrity, and trust in the investment profession by guiding the actions of chartered financial analysts. In place to: promote the integrity of CFA Institute members protect the integrity of the CFA Institute membership, designations, and exam programs serve as a model for measuring the ethics of investment professionals globally regardless of job function, cultural differences, or local laws and regulations. CFA Institute members (Chartered Financial Analyst (CFA) designation holders and CFA candidates) Are required to comply with the Code and standards Are encouraged to notify their employer of this responsibility Violations may result in disciplinary sanctions by the CFA Institute including: revocation of membership revocation of candidacy in the CFA Program revocation of the right to use the CFA designation 9 Code of Ethics Provides a broad summation of the character and professional conduct expected of CFA Charterholders and candidates in the finance industry Six Components of the Code of Ethics 1. Act with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets. 2. Place the integrity of the investment profession and the interests of clients above their own personal interests. Conflict of interest again… 3. Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities. 4. Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession. 5. Promote the integrity and viability of the global capital markets for the ultimate benefit of society. 6. Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals. 10  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 11 Standards of Professional Conduct 1a. Knowledge of the Law Know your business, know the rules! 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 stricter 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. Members must know the laws and regulations relating to their professional activities in all countries in which they conduct business. 12 Standards of Professional Conduct 1b. Independence and Objectivity 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  Do not let the investment process be influenced by any external sources. Where do gifts end  Modest gifts are permitted. and where does  Allocation of shares in oversubscribed initial public offerings (IPOs) to bribery start? personal accounts is NOT permitted.  Distinguish between gifts from clients and gifts from entities seeking influence to the detriment of the client.  Gifts must be disclosed to the member's employer in any case. 13 Standards of Professional Conduct 1c. Misrepresentation Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities. Trust is a foundation in the investment profession. Do not make any misrepresentations or give false impressions. This includes oral and electronic communications. Misrepresentations include guaranteeing investment performance and plagiarism. Plagiarism encompasses using someone else's work (e.g., reports, forecasts, charts, graphs, and spreadsheet models) without giving them credit. 14 Standards of Professional Conduct No fraud! Makes 1d. Misconduct sense, right?! 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. CFA Institute discourages unethical behavior in all aspects of members' and candidates' lives. Do not abuse CFA Institute's Professional Conduct Program by seeking enforcement of this Standard to settle personal, political, or other disputes that are not related to professional ethics. 15 Standards of Professional Conduct 1e. Competence A new standard that took effect on 01.01.2024 Members and Candidates must act with and maintain the competence necessary to fulfill their professional responsibilities The skills and abilities necessary for members and candidates to successfully fulfill their role vary according to the nature and complexity of their professional duties. As a result, there will be different criteria for competence for different members. An examination of the facts and circumstances of each member or candidate will dictate their expected conduct under this standard. Standard I(E) does not require members and candidates to engage in any specific program of professional development or continuing education. There are a variety of ways members and candidates can demonstrate and maintain competence when engaging in their professional responsibilities. 16 Standards of Professional Conduct In all cases: Case Professionalism 1) Use common sense 2) Be conservative in your judgement Shortly after becoming employed by Valco & Co., an investment banking firm, Stan McDowell, CFA, learns that most of Valco's initial public offerings (IPO) are really effected in order to profit management via price manipulation of the shares. McDowell observes an illegal act, sanctioned by senior management, in progress and refuses to sign off on his responsibility. Instead, McDowell takes the documentation to his supervisor and tells him he should sign it in his place. This action is: a) a suitable reaction, and he is in compliance with the Code and Standards. b) an overreaction. Senior management's sanctioning of the act absolves McDowell from his ordinary responsibility as a CFA Institute member. c) a violation of the Code and Standards since he is required not to knowingly participate or assist in such an act. 17  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 18 Standards of Professional Conduct 2a. Material Nonpublic Information Insider trading, ex. “Wall Street” 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. Information is considered material if its disclosure would impact the price of a security or if reasonable investors would want the information before making an investment decision. Ambiguous information, as far as its likely effect on price, may not be considered material. Information is nonpublic until it has been made available to the marketplace. An analyst conference call is not public disclosure. Selectively disclosing information by corporations creates the potential for insider-trading violations. Mosaic theory: There is no violation when a perceptive analyst reaches an investment conclusion about a corporate action or event through an analysis of public information together with items of nonmaterial, nonpublic information. 19 Standards of Professional Conduct 2b. Market Manipulation Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants. This Standard applies to transactions that deceive the market: by distorting the price-setting mechanism of financial instruments or by securing a controlling position to manipulate the price of a related derivative and/or the asset itself. Spreading false rumors is also prohibited. Like Spoofing, Layering, Quote Stuffing, Momentum ignition, Pump & Dump, … 20 Standards of Professional Conduct Case: Integrity of Capital Markets Andrea Waters is an investment analyst who has accumulated and analyzed several pieces of nonpublic information through her contacts with drug firms. Although no one piece of the information she collected is "material," Waters correctly concluded that the earnings of one of the drug companies would be unexpectedly high in the coming year. According to CFA Institute Standards of Professional Conduct, Waters: a) can use the information to make investment recommendations and decisions. b) cannot legally invest or make recommendations based on this information. c) may use the information, but only after approval from a compliance officer or supervisor. 21  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 22 Standards of Professional Conduct 3a. Loyalty, Prudence, and Care Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests. Client interests always come first: Determine and comply with applicable fiduciary duty to clients. Exercise the prudence, care, skill, and diligence under the circumstances that a person acting in a like capacity and familiar with such matters would use. Manage pools of client assets in accordance with the terms of the governing documents, such as trust documents or investment management agreements. Make investment decisions in the context of the total portfolio. Vote proxies in an informed and responsible manner. Client brokerage, or soft dollars or soft commissions must be used to benefit the client. 23 Standards of Professional Conduct 3b. Fair Dealing 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. Do not discriminate against any clients when disseminating recommendations or taking investment action. Fairly does not mean equally. In the normal course of business, there will be differences in the time e-mails, and so forth are received by different clients. Different service levels are okay, but they must not negatively affect or disadvantage any clients. Disclose the different service levels to all clients and prospects and make premium levels of service available to all who wish to pay for them. 24 Standards of Professional Conduct 3b. Fair Dealing Give all clients a fair opportunity to act upon every recommendation. Clients who are unaware of a change in a recommendation should be advised before the order is accepted. Treat clients fairly in light of their investment objectives and circumstances. Treat both individual and institutional clients in a fair and impartial manner. Members and Candidates should not take advantage of their position in the industry to disadvantage clients. 25 Standards of Professional Conduct 3c. Suitability This is, btw, what banks (must) do… 1. When Members and Candidates are in an advisory relationship with a client, they must: a. 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. c. Judge the suitability of investments in the context of the client’s total portfolio. 2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must make only investment recommendations or take only investment actions that are consistent with the stated objectives and constraints of the portfolio. 26 Standards of Professional Conduct 3d. Performance Presentation When communicating investment performance information, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete. Members must avoid misstating performance or misleading clients/prospects about investment performance of themselves or their firms, should not misrepresent past performance or reasonably expected performance, and should not state or imply the ability to achieve a rate of return similar to that achieved in the past. See also: Securities Act of 1933, Rule 156 (e.g. ww.Investopedia.com) Example of a Disclaimer: DISCLAIMER:Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from ClearRock Capital, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request. Source: ClearRock Capital, LLC 27 Standards of Professional Conduct 3e. Preservation of Confidentiality Members and Candidates must keep information about current, former, and prospective clients confidential unless: 1. The information concerns illegal activities on the part of the client or prospective client, 2. Disclosure is required by law, or 3. The client or prospective client permits disclosure of the information. If illegal activities by a client are involved, members may have an obligation to report the activities to authorities. The confidentiality Standard extends to former clients as well. The requirements of this Standard are not intended to prevent Members and Candidates from cooperating with a CFA Institute Professional Conduct Program (PCP) investigation. 28 Standards of Professional Conduct Case: Duties to Clients A money manager is meeting with a prospect. She gives the client a list of stocks and says, "These are the winners I picked this past year for my clients. Their double-digit returns indicate the type of returns I can earn for you." The list includes stocks the manager had picked for her clients, and each stock has listed with it an accurately measured return that exceeds 10%. Is this a violation of Standard III(D), Performance Presentation? a) Yes, unless the positions listed constitute a complete presentation (i.e., there were no stocks omitted that did not perform in the double digits). b) Yes, because the manager cannot reveal historical returns of recent stock picks. c) No, because the manager had the historical information in writing. 29  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 30 Standards of Professional Conduct 4a. Loyalty 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. Members must not engage in any activities which would injure the firm, deprive it of profit, or deprive it of the advantage of employees' skills and abilities. Always place client interests above interests of the employer. There is no requirement that the employee put employer interests ahead of family and other personal obligations; it is expected that employers and employees will discuss such matters and balance these obligations with work obligations. Clients come first! So does family… 31 Standards of Professional Conduct 4a. Loyalty Independent practice for compensation is allowed if a notification is provided to the employer fully describing all aspects of the services. Leaving an employer: Members must continue to act in their employer's best interests until resignation is effective. Whistle blowing: There may be isolated cases where a duty to one's employer may be violated in order to protect clients or the integrity of the market, and not for personal gain. 32 Standards of Professional Conduct 4b. Additional Compensation Arrangements 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. Compensation includes direct and indirect compensation from a client and other benefits received from third parties. Written consent from a member's employer includes e-mail communication. 33 Standards of Professional Conduct 4c. Responsibility of Supervisors 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. Members must take steps to prevent employees from violating laws, rules, regulations, or the Code and Standards and make reasonable efforts to detect violations. Understand that an adequate compliance system must meet industry standards, regulatory requirements, and the requirements of the Code and Standards. Members with supervisory responsibilities have an obligation to bring an inadequate compliance system to the attention of firm's management and recommend corrective action. While investigating a possible breach of compliance procedures, it is appropriate to limit the suspected employee's activities. 34 Standards of Professional Conduct Case: Duties to Employers Bill Valley has been working for Advisors, Inc., for several years, and he just joined CFA Institute. Valley's sister just received a large bonus in the form of stock options in Zephyr, Inc. Valley's sister knows nothing about financial assets and offers Valley a week at her holiday home each year in exchange for Valley monitoring Zephyr and the value of her stock options. In order to comply with the Code and Standards, Valley needs to inform Advisors of: a) nothing since no money is involved and it is a favor for a family member. b) the compensation in the form of the use of the holiday home only. c) both the use of the holiday home and his sister's options. 35  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 36 Standards of Professional Conduct 5a. Diligence and Reasonable Basis Members and Candidates must: 1. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions. 2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action. Remember: NO insider trading! 37 Standards of Professional Conduct 5a. Diligence and Reasonable Basis The application of this Standard depends on the investment philosophy adhered to, members' and candidates' roles in the investment decision-making process, and the resources and support provided by employers. These factors dictate the degree of diligence, thoroughness of research, and the proper level of investigation required. Using secondary or third-party research: See that the research is sound. Group research and decision making: Even if a member does not agree with the independent and objective view of the group, he does not necessarily have to decline to be identified with the report, as long as there is a reasonable and adequate basis. 38 Standards of Professional Conduct 5b. Communication with Clients and Prospective Clients Transparency, full disclosure Members and Candidates must: 1. 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. Disclose to clients and prospective clients the nature of the services provided, along with information about the costs to the client associated with those services (addition valid since 01.01.2024). 2. 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 analysis and recommendations. 39 Standards of Professional Conduct 5b. Communication with Clients and Prospective Clients Members must distinguish between opinions and facts and always include the basic characteristics of the security being analyzed in a research report. Members must illustrate to clients and prospects the investment decision-making process utilized. The suitability of each investment is important in the context of the entire portfolio. All means of communication are included here, not just research reports. I think vs. I know 40 Standards of Professional Conduct 5c. Record Retention 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. Members must maintain research records that support the reasons for the analyst's conclusions and any investment actions taken. Such records are the property of the firm. If no other regulatory standards are in place, CFA Institute recommends at least a 7-year holding period. 41 Standards of Professional Conduct Case: Investment Analysis, Recommendations, and Actions Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. It is Hatfield's opinion that interest rates will fall in the near future. Based upon this, Hatfield begins increasing the bond allocation of each portfolio. In order to comply with Standard V(B), Communication with Clients and Prospective Clients, the analyst needs to: a) make sure that the change is identical for both clients. b) inform the clients of the change and tell them it is based upon an opinion and not a fact. c) perform both of these functions. 42  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 43 Standards of Professional Conduct Transparency, full 6a. Disclosure of Conflicts / Avoid or Disclose Conflicts disclosure again… Members and Candidates must (**avoid or) 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. ** effective since 01.01.2024 The requirement that all potential areas of conflict be disclosed allows clients and prospects to judge motives and potential biases for themselves. Disclosure of broker/dealer market-making activities would be included here. Board service is another area of potential conflict. The most common conflict which requires disclosure is actual ownership of stock in companies that the member recommends or that clients hold. Members must give the employer enough information to judge the impact of the conflict. Take reasonable steps to avoid conflicts, and report them promptly if they occur. 44 Standards of Professional Conduct 6b. Priority of Transactions Investment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner. Client transactions take priority over personal transactions and transactions made on behalf of the member's firm. Personal transactions include situations where the member is a beneficial owner. Personal transactions may be undertaken only after clients and the member's employer have had an adequate opportunity to act on a recommendation. Note that family member accounts that are client accounts should be treated just like any client account-they should not be disadvantaged. Clients come first, i.e. NO front-running! 45 Standards of Professional Conduct 6c. Referral Fees Members and Candidates must disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services. Members must inform employers, clients, and prospects of any benefit received for referrals of customers and clients, allowing them to evaluate the full cost of the service as well as any potential impartiality. All types of consideration must be disclosed. Conflict of interest again… 46 Standards of Professional Conduct Case: Conflicts of Interest Jan Hirsh, CFA, is employed as manager of a college endowment fund. The fund's board has recently voted to divest any stocks of tobacco companies from the portfolio. Hirsh currently owns shares of a major tobacco company. According to the Standards, Hirsch must: a) do nothing. b) disclose his ownership in the stocks to the board or sell his shares. c) disclose his ownership in the stocks to his supervisor or compliance officer. 47  Standards of Professional Conduct Ethical responsibilities 1. Professionalism: 5. Investment Analysis, Recommendations, and a) Knowledge of the Law Actions: b) Independence and Objectivity a) Diligence and Reasonable Basis c) Misrepresentation b) Communication with Clients and Prospective Clients d) Misconduct (revision came into effect on 01.01.2024), e) Competence (came into effect on 01.01.2024) c) Record Retention 2. Integrity of Capital Markets: 6. Conflicts of Interest: a) Material Nonpublic Information a) Avoid or Disclose Conflicts (new name since 01.01.2024) b) Market Manipulation b) Priority of Transactions, c) Referral Fees 3. Duties to Clients: a) Loyalty, Prudence, and Care 7. Responsibilities as a CFA Institute member or as a b) Fair Dealing CFA candidate: c) Suitability a) Conduct as Participants in CFA Institute Programs d) Performance Presentation b) Reference to CFA Institute, the CFA designation, and the e) Preservation of Confidentiality CFA Program 4. Duties to Employers: a) Loyalty The new 12th edition of the Handbook came into effect on 1 January 2024 b) Additional Compensation Arrangements c) Responsibility of Supervisors 48 Standards of Professional Conduct 7a. Conduct as Participants in CFA Institute Programs 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 the CFA Institute programs. This Standard applies to conduct which includes: Cheating on the CFA exam or any exam. Not following rules and policies of the CFA program. Giving confidential information on the CFA program to Candidates or the public. Improperly using the designation to further personal and professional goals. Misrepresenting information on the Professional Conduct Statement (PCS) or the CFA Institute Professional Development Program. Members and Candidates are not precluded from expressing their opinions regarding the exam program or CFA Institute. 49 Standards of Professional Conduct 7b. Reference to CFA Institute, the CFA designation, and the CFA Program When referring to CFA Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA Program, Members and Candidates must not misrepresent or exaggerate the meaning or implications of membership in CFA Institute, holding the CFA designation, or candidacy in the CFA program. Members must not make promotional promises or guarantees tied to the CFA designation. Do not overpromise individual competence or investment results in the future (i.e., higher performance, less risk, etc.). Members must satisfy these requirements to maintain membership: 1) sign PCS (Professional Conduct Statement) annually, and 2) pay CFA Institute membership dues annually. If they fail to do this, they are no longer active members. 50 Standards of Professional Conduct 7b. Reference to CFA Institute, the CFA designation, and the CFA Program There is no partial designation. It is acceptable to state that a Candidate successfully completed the program in three years, if in fact they did, but claiming superior ability because of this is not permitted. The Chartered Financial Analyst and CFA marks must always be used either after a charterholder's name or as adjectives, but not as nouns, in written and oral communications. 51 GIPS: Global Investment Performance Standards Developed by: CFA Institute Governed by: GIPS Executive Committee For usage by: Investment Managers Type: Voluntary Standards What it is: A standardized, industry-wide set of ethical principles for calculating and presenting the performance history of investment firms to potential and existing clients 52 GIPS: Global Investment Performance Standards Purpose: To ensure full disclosure and fair representation of the investment performance of investment managers To allow investors easier comparison of the performance of investment firms To provide investors with more confidence concerning a firm’s reported performance To avoid misrepresentations of historical investment results to clients and prospects To incentivize firms to invest significant time and resources into internal risk-control mechanisms and setting performance benchmarks To increase transparency and eliminate survivorship biases, misrepresentations and historical data omissions through composite presentation 53 GIPS: Global Investment Performance Standards Composite Presentation A composite is a grouping of discretionary portfolios that share a similar investment objective, strategy, or mandate. A composite must include all portfolios (current and past) that the firm has managed in accordance with this particular strategy. The firm should identify which composite each managed portfolio is to be included in before the portfolio's performance is known. The performance of a composite is represented as a single entity Helps to accurately portray the firm’s ability to manage a particular strategy over time 54 GIPS: Global Investment Performance Standards GIPS contain both required and recommended provisions. Certain recommendations may become requirements in the future. Firms must include all fee-paying, discretionary portfolios in composites for a minimum of five years or since firm or composite inception. Total firm assets include the total market value of discretionary and nondiscretionary assets, including fee-paying and non-fee-paying accounts. There is no such thing as partial compliance. Not allowed: Statements referring to calculation methodologies used in a composite presentation as being "in accordance with GIPS." Statements referring to the performance of an individual client as being "calculated in accordance with GIPS" unless a compliant firm is reporting results directly to the client. 55 GIPS: Global Investment Performance Standards Nine major sections of the GIPS standard 1. Fundamentals of Compliance. These are issues for firms to consider when claiming GIPS compliance (e.g., firm definition). 2. Input Data. Input data should be consistent in order to establish full, fair, and comparable investment performance presentations. 3. Calculation Methodology. Certain uniform methodologies are required for portfolio and composite return calculations. 4. Composite Construction. Creation of meaningful, asset-weighted composites is important to achieve a fair presentation. 5. Disclosures. Certain information must be disclosed about the presentation and the policies adopted by the firm. 6. Presentation and Reporting. Investment performance must be presented according to GIPS requirements, and when appropriate, other firm-specific information should be included. 7. Real Estate. These provisions apply to all real estate investments regardless of the level of control the firm has. 8. Private Equity. These must be valued according to the GIPS Private Equity Valuation Principles, unless it is an open-end or evergreen fund (which must follow regular GIPS). 9. Wrap Fee/Separately Managed Account (SMA) Portfolios. Certain special GIPS standards apply to these. 56 GIPS: Global Investment Performance Standards GIPS Verification Process Firms are encouraged to pursue independent verification of GIPS compliance. If they seek verification, it must be performed by a third party, not by the firm itself. The third-party verifier must attest that 1. the firm has complied with all GIPS requirements for composite construction on a firm-wide basis, and 2. the firm's processes and procedures are established to present performance in accordance with the calculation methodology required by GIPS, the data requirements of GIPS, and in the format required by GIPS. 57 How to Become a CFA Charterholder 1) Pass the CFA Exams Levels I, II, III Practical Skills Modules (NEW!) Practical, relevant skills training for on-the-job application of what is learned in the curriculum Level I candidates: Beginning with the February 2024 exam Level II candidates: Beginning with the May 2024 exam Level III candidates: 2025 exams 2) Achieve Qualified Work Experience May be completed before, during, or after participation in the CFA Program. Experience must be directly involved with the investment decision-making process or producing a work product that informs or adds value to that process. 3) Submit Reference Letters For the membership application, 2-3 professional references are required. References will be asked to comment on your work experience and professional character 4) Apply to Become a Charterholder Apply to become a regular member of CFA Institute. Once your application is approved and you have joined CFA Institute, you will have earned the CFA charter. 58