CFA Institute Ethics Quiz #3 PDF

WEEK 7: STANDARD 1 PROFESSIONALISM Code of ethics SUMMARY A) Conduct: a) Act with integrity, competence, diligence, and respect. b) Uphold ethical standards in all professional interactions. B)...

WEEK 7: STANDARD 1 PROFESSIONALISM Code of ethics SUMMARY A) Conduct: a) Act with integrity, competence, diligence, and respect. b) Uphold ethical standards in all professional interactions. B) Client Interests: a) Prioritise the integrity of the investment profession and client interests over personal gains. C) Professional Judgement: a) Use reasonable care and independent judgement in investment analysis and actions. D) Professional Practice: a) Encourage ethical behaviour and professionalism in oneself and others. E) Market Integrity: a) Promote and maintain the integrity of global capital markets for society's benefit. F) Competence: a) Continuously improve professional skills and support others in doing the same. 1A Knowledge of the law Definition: must adhere to all relevant laws and regulations governing their professional activities, follow the stricter standard in case of conflict, and avoid involvement in any violations. ★ Applicable law: the law that governs a CFA institutes members conduct@ - Following CFA Standards - Must dissociate from illegal or unethical activities if reasonably suspected → may require resigning 1. Knowledge of law: not required to be an expert, but need seek advice if unsure 2. Complete hierarchy: adhere to laws and CFA code standards 3. Responsibility for Violations: be accountable for participation in violations 4. Global compliance: following stricter local laws when practices in multiple jurisdictions EXAMPLE of not complying with knowledge of law Jameson, working in a country with strict IPO regulations, ignores local laws, believing compliance with U.S. laws and CFA Code suffices 1B Independence Definition: independence and objectivity to avoid conflicts of interest that could affect professional and Objectivity judgement. ★ Cannot accept lavish gifts from providers/partners - even if it’s disclosed ★ CAN accept gifts from clients, given that its disclosed to EMPLOYER ★ Best practice is to reject any offer that could threaten independency and objectivity - Personal responsibility: research for unbiased opinions - External influences: be cautious of attempts by others to influence investment decision - Performance analysis: resist changing performance analysis due to negative results or external pressures - Public companies: analyst may face pressure to issue favourable reports ★ Analysts should resist pressure and maintain objectivity - Credit rating agencies: ensure rating processes prevent undue influence from companies during fixed-income product analysis - Manager selection: maintain independence and objectivity when hiring managers - Issuer paid research: be wary of conflicts in issuer paid research, which can mislead investors into thinking it’s independent analysis - Travel funding: accepting paid travel which could lead to bias Example: Taylor accepts Precision Metals’ paid accommodations during a tour, while Adams pays for his own to follow his company policy. AND Grant accepts World Cup tickets and luxury accommodations from a brokerage house as a reward for business directed their way 1C. Misrepresentation Definition: don’t knowingly make any misrepresentations leading to investment analysis, actions etc. - Avoid false statements, omissions, or misleading information → no guarantee on any return as all investments contain some risk which makes it inherently unpredictable - Third party info: use diligence when using external data, you are responsible for any misrepresentations in your work - Investment performance: do not guarantee any returns or compare performance to inappropriate benchmarks - Social media: ensure communications comply with codes and standards - Omissions: omitting facts can be misleading, especially with models and analysis ★ Omitting facts means FAILURE to state important info - Plagiarism: don’t plagiarise, always credit sources - Compliance practices: describe qualifications, monitor online content, maintain documents, attribute quotes and summarised Example: - Yao distributes marketing materials with incorrect asset information due to a typo. - Zubia plans to use descriptions from other sources in marketing without proper attribution. 1D. Misconduct Definition: Any dishonest act that damages professional integrity or reputation - involves dishonesty, fraud or deceit that impacts reputation Compliance Practices: Encourage firms to adopt a code of ethics prohibiting personal behaviour that reflects poorly on the profession. Example: - Sasserman makes investment decisions while intoxicated after lunch, affecting his judgement. - Brink overcharges a charity to pay a personal debt, splitting the excess with a friend. 1E. Competence Maintain knowledge, skills, and diligence to provide high professional service and uphold the Code of Ethics. ★ Mentoring, providing access to resources to resources and offering training opportunities Compliance Practices: Engage in ongoing education, certifications, training, self-study, and skill development. Example: integrating ESG work into research, preparing new responsibilities, WEEK 8: STANDARD 2 INTEGRITY OF CAPITAL MARKETS Summary of Standard 2 Members and candidates who possess material non-public info that could affect the value of an Handling Material investment must not act or cause others to act on the information. non-public information Material: anything that could impact security prices or influence investor decision making → alters price Non public: info not released to the general marketplace → disclosed to select individuals, which can lead to insider trading risks Examples of material: earnings, corporate actions e.g M&A, changes in asset management, events affecting securities e.g dividend changes KEY CONCEPTS A) Public Dissemination: Ensure that material information is released to the general public. B) Compliance Procedures: Adopt strict procedures to prevent the misuse of material nonpublic information. C) Press Releases: Use press releases to disseminate material information broadly. D) Firewall Restrictions: Adhere to restrictions that prevent the flow of sensitive information between different departments. E) Personal Trading Limitations: Set limitations on personal trading to avoid conflicts of interest. 1. Matariel of - Impact on market confidence: undermines trust in capital markets and institutions non public - Impression of unfair advantage for insiders —> economic inefficiency informatio n A) The mosaic - Analysts use a combo of public and non-public material to make investment decisions theory (known as a mosaic) - Conclusions drawn from the mosaic ARE NOT a violation, even if they obtained directly from the company - Analysts MUST document research to show conclusions Social media use: considered public only if it’s accessible to all → investors must ensure info from restricted groups is also publicly accessible before making investments Industry experts: is permissible, but must avoid on acting on confidential info Analyst reports: can significantly impact the market and can be considered ‘material’ - analysts do not need to make conclusions public, investors must either do their own research Example of misuse - Insider info shared among family members leading to stock trading of non public info - An analyst receives nonpublic information about an impending strike and considers using it to change a stock rating. 2. Market Definition: actions that distort security prices or trading volume to deceive market participants Manipulation EXAMPLE: overstating an earnings projection to increase stock price. 2 Main types ○ Information-based Manipulation: Spreading false or misleading information (rumours) ○ Transaction-based Manipulation: Conducting trades that mislead others about the true value of a security → price setting mechanisms e.g pumps up the stock prices using two client accounts. - It is spotted through unusual changes in price and trading volume! Acceptable conduct: employing trading strategies that exploit market inefficiencies Compliance Compliance: procedures and examples - Implement measures like order management systems, pre-trade controls, and trade exception reporting to prevent and detect manipulative practices. - Monitor suspicious activities, such as wash trading and cross-product transactions designed to manipulate prices. ★ Order management systems are used to prevent manipulative trading practices Example: - Multiple accounts and spreading rumours to manipulate price and volume - Issuing speculative research reports to benefit hedge fund clients WEEK 9: STANDARD 3 INTEGRITY OF CAPITAL MARKETS AREAS TO COVER: - A. Loyalty, Prudence, and Care - B. Fair Dealing - C. Suitability - D. Performance Presentation. - E. Preservation of Confidentiality Definition: must prioritise clients interest over there own or employers, acting with loyalty, 2A) Duty to clients; prudence and care Loyalty, Prudence, ★ Employees must disclose if they are outsourcing services that are purchased by clients → and Care posting on website is NOT enough  - Fiduciary Duties (where one party places trust aka confidential relationship) → the duty of loyalty and care exceeds regular business obligations, though not all members are legally required/. - Non-advisory Services: Trade execution professionals must ensure trades are executed in the client's best interest. - Identifying the Client: A client is anyone receiving a professional service for compensation. - Client Portfolio Management: Managers must ensure clients' objectives are realistic and suitable, and investment decisions should be judged in the context of the entire portfolio. - Soft Commissions: Conflicts may arise with brokerage selection. Members must seek the best price and execution, ensuring services benefit account beneficiaries. - Proxy Voting Policies: Members must vote proxies in an informed manner to maximise returns. - Compliance Procedures: - Provide regular account information. - Obtain client approval. - Establish clear investment objectives. - Consider all relevant information when acting. - Diversify portfolios. - Conduct regular reviews. - Avoid or disclose conflicts of interest. - Disclose compensation arrangements. - Maintain confidentiality. - Seek best execution. Soft dollars: are commission payments to a brokerage firm that are used to pay for other services such as research. Instead of paying with cash, the fund will pay in-kind by passing on business to the brokerage. - brokerage commissions should NOT be pooled to assist all clients. EXAMPLE: - Jackson directs most of his firm’s trading through a brokerage due to personal connections, despite higher costs and average service quality, receiving benefits such as rent coverage Multiple choice example: 1. Phoung gives discounts to clients who have over $25mill in investments, and provides personalised services. → ANSWER: he is NOT in violation as long as he doesn’t disadvantage other clients, and has disclosed this difference in service to ALL his clients. 2. John Steward has been hired by Goodner Industries to manage it’s pension fund. Stewards duty of loyalty, prudence and care is owed to: ANSWER → the participants and beneficiaries of Goodners pension plan 2B) Fair dealing Definition: members must deal fairly with all clients when providing investment analysis or engaging  in any other professional activities ★ No client should be advantaged/disadvantaged including family members - Fair treatment: members must treat all clients fairly when making investment recommendations or taking investment - Fairness vs equity: avoid discrimination, not ‘equally’ as all clients have different needs - Investment action: must be allocated fairly to all clients. If oversubscribed, professions must forgo personal allocations unless managed the same to other clients Compliance Practices: a) Follow firm policies. b) Limit people involved. c) Shorten the time between decision and dissemination. d) Simultaneously disseminate information. e) Maintain a client holdings list. f) Develop and disclose trade allocation procedures. g) Establish systematic account reviews and disclose service levels. Example on not following; Morris arranges personal benefits from a public offering, risking conflict of interest with clients' allocations. Multiple choice example: Reza is an investment manager whose paying clients include his parents and siblings. Under Code and Standards, Reza should treat all clients fairly by: ANSWER → not treating his family member accounts any differently from OTHER client ACCOUNTS 2C) Suitability Definition: when members and candidates are in an advisory relationship with a client, they must A) Make a reasonable inquiry into clients investment experience, risk and return objectives and constraints B) Determine if investment is suitable to financial situation and consistent with written objectives C) Just if the investment is suitable in the context of clients TOTAL portfolio ★ An investment manager can judge the suitability of a particular investment for a client regardless of the suitability of investment for the manager's other clients! Advisory Relationship Requirements: - Inquire into the client's investment experience, risk/return objectives, and financial constraints. - Ensure investments are suitable and aligned with client objectives and mandates. - Assess investment suitability in the context of the total portfolio. Suitability guidance: professionals must assess client needs, circumstances and objectives - Understanding client knowledge, experience and financial situation  - Develop a written INVESTMENT POLICY STATEMENT (IPS): outlining: risk tolerance, return objectives and constraints → reviewed annually or before any significant investment changes Client risk profile: changing investment environments and impacts on client holdings Diversification: must happen to manage risk effectively Unsolicited trading requests: balance client trading requests with IPS responsibilities Compliance Procedures: Client identification, expectations, and constraints. Regular updates and suitability testing. Develop trade allocation and performance benchmarks. Example: NOT OBEYING: Example 1: Smith recommends aggressive investments to two clients with differing risk profiles, which is unsuitable. OBEYING: Example 5: Gubler invests 4% of a portfolio in venture capital funds, ensuring it remains within the portfolio's equity exposure limit. 2D) Performance Definition: members must ensure that performance is fair, accurate and complete presentation ★ Performance presentation requires a far and complete presentation of information with respect to history of I. individual accounts Ii. composite or groups of accounts Iii. investment funds Guidance: - Provide credible performance information - Encourage full disclosure of investment performance data Compliance with GIPS standards: - Use standards to meet obligations for fair performance history. - If firms do not comply with GIPS, members can a) Consider audience knowledge b) Present composite performance c) Maintain data and records supporting performance calculations Example: NOT OBEYING: Taylor Trust falsely claims 25% annual growth, which was only achieved in one year and is misleading without context of past performance.  NOT OBEYING: Singh’s firm manipulates reporting by selectively showing the highest performance calculation, without labelling the return type, misleading clients. 2E) Preservation of confidentiality Confidentiality Requirements: Members and candidates must keep client information confidential unless: 1. The information concerns illegal activities. 2. Disclosure is required by law. 3. The client or prospective permits disclosure. Guidance: - Confidentiality must be maintained, even when client relationship ends - Compliance with laws is required - Limited disclosure may be allowed for vulnerable investors Electronic information: professionals must be cautious of accidental disclosures via electronic mediums CFA Institutes Investigations: members must cooperate with professional conduct investigations unless legally prohibited Compliance practices: - Share client info only with authorised colleagues - Follow firm procedures for handle of electronic info - Follow legal guidelines Example: NOT OBEYING EXAMPLE: Moody’s client mistakenly shares personal information on a public group page, OBEYING EXAMPLE: Connor does not disclose confidential information about City Medical Center’s plans when approached by an external party.