COURSE CONTENT

Applicable CFA standards and

examples

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REGULATORY ANALYSIS

Sources:
• CFA Institute curriculum
• CFA Standards of practice handbook
• Sample of local and international laws, regulations, and professional standards
• Various internet sites from professional organizations
• Author’s documentation

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APPLICABLE STANDARDS AND EXAMPLES

• The CFA Standards of Practice Handbook (Handbook) provides guidance to

the people who grapple with real ethical dilemmas in the investment profession
on a daily basis. The Handbook addresses the professional intersection where
theory meets practice and where the concept of ethical behavior crosses from
the abstract to the concrete.
• The Handbook is intended for a diverse and global audience :
- CFA Institute members navigating ambiguous ethical situations.
- Supervisors and direct/indirect reports determining the nature of their
responsibilities to each other.
- Existing and potential clients.
- Broad financial markets constituents.
- Candidates preparing for the Chartered Financial Analyst (CFA)
examinations.

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APPLICABLE STANDARDS
AND EXAMPLES

1. Independence and Objectivity.

2. Misrepresentation.
3. Integrity of Capital Markets.
4. Diligence and Reasonable Basis.
5. Communication with Clients and Prospective Clients.

A brief sample of relevant examples is provided in the following sections.

All subsequent examples are taken from the Handbook.

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APPLICABLE STANDARDS AND EXAMPLES

Standard I (B) 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.

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APPLICABLE STANDARDS AND EXAMPLES

Example: 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.

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APPLICABLE STANDARDS AND EXAMPLES

Guideline answer: Research Independence and Prior Coverage

• 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.
- 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.

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APPLICABLE STANDARDS AND EXAMPLES

Standard I (C) Misrepresentation

• Members and Candidates must not knowingly make any misrepresentations
relating to investment analysis, recommendations, actions, or other
professional activities.

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APPLICABLE STANDARDS AND EXAMPLES
Example: 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.”

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APPLICABLE STANDARDS AND EXAMPLES

Guideline answer: Plagiarism

• 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.

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APPLICABLE STANDARDS AND EXAMPLES

Standard II: Integrity of Capital Markets

• Standard II(A) Material Nonpublic Information
• 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.

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APPLICABLE STANDARDS AND EXAMPLES

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APPLICABLE STANDARDS AND EXAMPLES

• A financial analyst gathers and interprets large quantities of information from

many sources.
• The analyst may use significant conclusions derived from the analysis of
public and nonmaterial nonpublic information as the basis for investment
recommendations and decisions even if those conclusions would have been
material inside information had they been communicated directly to the analyst
by a company.
• Under the “mosaic theory,” financial analysts are free to act on this collection,
or mosaic, of information without risking violation.

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APPLICABLE STANDARDS AND EXAMPLES

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Example: Applying the Mosaic Theory
• Roger Clement is a senior financial analyst who specializes in the European
automobile sector at Rivoli Capital. He has been repeatedly nominated by
many leading industry magazines as a “best analyst” for the automobile
industry and is widely regarded as an authority on the sector.
• After speaking with representatives of Turgot Chariots - a European auto
manufacturer with sales primarily in South Korea - and after conducting
interviews with salespeople, labor leaders, his firm’s Korean currency analysts,
and banking officials, Clement analyzed Turgot Chariots and concluded that:
- Its newly introduced model will probably not meet sales expectations.
- Its corporate restructuring strategy may face serious opposition from unions.
- The depreciation of the Korean won should lead to pressure on margins for
the industry in general and Turgot’s market segment in particular.
- Banks could take a tougher-than-expected stance in the upcoming round of
credit renegotiations with the company.
• For these reasons, he changes his conclusion about the company from
“market outperform” to “market underperform.” Clement retains the support
material used to reach his conclusion in case questions later arise.

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APPLICABLE STANDARDS AND EXAMPLES

Guideline answer: Applying the Mosaic Theory

• To reach a conclusion about the value of the company, Clement has pieced
together a number of nonmaterial or public bits of information that affect
Turgot Chariots.
• Therefore, under the mosaic theory, Clement has not violated Standard II(A)
in drafting the report.

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APPLICABLE STANDARDS AND EXAMPLES

Standard V: Investment Analysis

Standard V(A) 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.

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APPLICABLE STANDARDS AND EXAMPLES

Example: Developing a Reasonable Basis

• Brendan Witt, a former junior sell-side technology analyst, decided to return
to school to earn an MBA.
• To keep his research skills and industry knowledge sharp, Witt accepted a
position with On-line and Informed, an independent internet-based research
company. The position requires the publication of a recommendation and
report on a different company every month.
• Initially, Witt is a regular contributor of new research and a participant in the
associated discussion boards that generally have positive comments on the
technology sector. Over time, his ability to manage his educational
requirements and his work requirements begin to conflict with one another.
• Knowing a recommendation is due the next day for On-line, Witt creates a
report based on a few news articles and what the conventional wisdom of the
markets has deemed the “hot” security of the day.

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APPLICABLE STANDARDS AND EXAMPLES

Guideline answer: Developing a Reasonable Basis

• Witt’s knowledge of and exuberance for technology stocks, a few news articles,
and the conventional wisdom of the markets do not constitute, without more
information, a reasonable and adequate basis for a stock recommendation
that is supported by appropriate research and investigation.
• Therefore, Witt has violated Standard V(A).

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APPLICABLE STANDARDS AND EXAMPLES

Standard V (B) Communication with Clients and Prospective Clients

• 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.
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
analyses and recommendations.

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APPLICABLE STANDARDS AND EXAMPLES

Example: 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 US 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.

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APPLICABLE STANDARDS AND EXAMPLES

Guideline answer: Proper Description of a Security

• 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.

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