CFA Level 1: Ethical and Professional Standards

by Andy Solnik [email protected] For more CFA study resources visit my blog at http://www.financialanalystexam.com I wish you all the best for the CFA Exam! ______________________________

List the 7 standards of professional conduct

I. professionalism: a, b, c, d II. integrity of capital markets: a, b III. duties to client: a, b, c, d, e IV. duties to employers: a, b, c V. investment analysis, recommendations and actions: a, b, c VI. conflicts of interest: a, b, c VII. responsibilities as a CFA institute member or cfa candidate: a, b ______________________________

List the code of ethics (6)

act with integrity, competence, diligence, respect and in ethical manner towards clients, employers, employees, colleagues and other participants in global markets integrity of investment profession and client interest > personal interest use independent professional judgment and care when conducting investment analysis, making recommendations and taking investment actions practice ethically and professionally and encourage others to do so promote integrity and uphold the rules governing capital markets maintain and improve professional competence and help others to do so

in general: "at all times, act in ethical manner, as you hold a position of responsibility" ______________________________

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Explain standard I. (4)

a) knowledge of the law: in case of conflict, stricter jurisdiction or the ethical code/standards are the yardstick b) maintain independence and objectivity c) avoid misprepresentation of analysis, recommendations, actions (promising returns / no losses etc., plagiarism of materials) d) avoid misconduct like fraud, dishonesty or deceit. anything that reflects badly on professional integrity. ______________________________

what to do if two jurisdictions conflict with each other?

abide by the stricter law, rule or regulation ______________________________

Explain standard II. integrity of capital markets (2)

a) do not act upon material nonpublic information or solicit it b) refrain from market manipulation ______________________________

Explain standard III. duties to client (5)

a) loyalty, prudence, care b) fair dealing c) suitability: inquire about client's experience, risk/return objectives, financial constraints. determine if investment suitable to client's situation and written objectives. judge suitability in contact of total portfolio. consistency with objectives of portfolio. d) performance presentation: fair, accurate, complete e) preservation of confidentiality, unless illegal, required by law, disclosure permitted. CFA oversight board must be given access to confidential client information. ______________________________
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Explain standard IV. duties to employers (3)

a) loyalty: not deperive of insight, divulge confidential info, cause harm b) avoid conflict of interest, additional compensation agreements, unless written consent from all parties involved c) responsibilities of supervisors to detect fraud, illegal activity ______________________________

Explain standard V. investment analysis, recommendations, actions (3)

a) diligence and reasonable basis for analysis b) communication with clients and prospective clients: disclose any vital changes, distinguish between fact and opinion c) record retention ______________________________

What are the elements (3) of CFA Standard VI?

Standard VI: Conflict of Interest: A) Disclosure of conflicts that could impact independence and objectivity, and interfere with duties B) Priority of transactions: client > advisor C) Disclosure of referral fees ______________________________

Explain standard VII. responsibilities as CFA members (2)

a) conduct as members in CFA program must avoid tarnishing its reputation b) realistic reference to CFA institute, designation, program: do not exaggerate its meaning (e. g. "I am a CFA institute member, I know what I am talking about, you should do what I say.") ______________________________

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is it mandatory to report violations of code and standards to CFA institute?

no ______________________________

what are key elements of the firewall between investment-banking and research? 3
1. separate reporting structures for both -> investment-banking personnal cannot veto or influence research reports 2. analyst's remuneration separate from investment-banking assignments of team 3. clear policy to improve transparency of prominent, specific disclosures ______________________________

why is a firewall needed between investment banking and research departments? 2

pressure from sell-side firms for benevolent research coverage investment banking prime profit source for banks, may exert pressure on analysts or supply biased information ______________________________

Explain the sources of analyst bias, 4

1. sell-side pressure (investment-banking, IPOs) 2. buy-side pressure (portfolio managers) 3. pressure from public companies, barring "negative" analysts 4. issuer-paid research ______________________________

Explain compliance procedures with standard I (b) independence/ objectivity, 7

1. incentive schemes separate from opinion, integrity of opinions 2. restricted list with controversial companies or remove them from coverage 3. restricted special cost arragements, payment of travel cost 4. gift limit 5. restrict employee purchases of equity IPOs (insider trading) 6. employee investments reviewed
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7. policy of independence of opinion (formal, written): nobody controls analyst reports ______________________________

is it in violation of standard I (b) (independence, objectivity) to accept payments for travel arrangements?
not a violation, but members must use judgment and objectivity. hospitality should not be irrelevant or overly lavish ______________________________

why is disclosure of gifts necessary?

so that supervisors can monitor the employee who received the gift, so as not to favour the gift-giving client over other fee-paying clients (e. g. allocating a greater proportion of IPO stock to the client's portfolio) ______________________________

Explain the steps to avoid plagiarism (3)

1. maintain copies of all research material used 2. attribute quotations, formulas, graphs etc. 3. attribute summaries, acknowledge reliance on other analyst's reports when summarizing them ______________________________

do conduits (e. g. newspapers) need to be quoted in research?

not necessarily. only the source of the information needs to be quoted. conduits should be quoted if they added additional information or value. ______________________________

Explain compliance procedure with standard I (d), misconduct (3)

1. employees must subscribe to code of ethics barring misconduct 2. make public list of potential violations and consequences (including dismissal) 3. check references for ethical behaviour ______________________________

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does any legal transgression stand in violation of standard I (d), misconduct?

transgressions associated with civil disobedience related to personal beliefs do not violate standard I (d), as long as they do not reflect poorly on the individual. in general, only transgressions of the law that would reflect poorly on the individual's professionalism, the investment profession or CFA institute violate the standard. ______________________________

when is information "material"?

when it would have an impact on the price of a security or when reasonable investors would want to know it before making an investment decision. ______________________________

Give examples of material information (5)

- mergers - earnings - management changes - legal disputes - innovations etc. ______________________________

when is information nonpublic?

no public dissemination: when it has not been made known to the marketplace in general (as opposed to a select group of investors or analysts) ______________________________

Is information made available to analysts nonpublic?

Yes, until is has been made available to the marketplace. ______________________________

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Define mosaic theory

mosaic of public and nonmaterial nonpublic information may yield conclusions that may be same as material nonpublic information. such insight may be used for investment decisions without disclosure to the public. analysts may use significant conclusions from public and nonmaterial nonpublic information for investment decisions even if they would have been equal to material nonpublic information, had they been communicated to an analyst directly by a company, without risking violation. ______________________________

Explain the elements of firewall preventing flow of material nonpublic information between firms or departments (5)
1. clearance area, compliance officer controls flow of information between departments 2. "watch", "restricted" and "rumor" lists and self-disclosed periodic reports to review employee trading 3. documentation of procedures designed to limit flow of information and communications 4. review or restriction of proprietary trading while a firm posesses material nonpublic information 5. physical separation of departments, no overlap of personnel ______________________________

is failing to prevent transfer and misuse of material nonpublic information to sensitive areas in the firm a violation of standard II (a)?
yes. the person who failed to prevent the information transfer and those who acted on the information are both in violation of II (a)., material nonpublic information. ______________________________

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can material information learned at a company meeting be used for investment decisions?
only if it is public, if it is nonpublic, such information cannot be used. ______________________________

transaction-based market manipulation [standard II (b)] includes: 2

1. artificially distorting prices or volume to give impression of activity or price movement through trading, information timing or false information 2. securing a controlling position in financial instrument to manipulate price of related derivative and/or underlying asset ______________________________

to have "custody" in a financial relationship with a client means...

having direct or indirect access to client assets custody, n. = protective care ______________________________

Define soft dollars / soft commissions

use client brokerage to purchase goods or services that do not benefit the client. should be disclosed to client in order to avoid conflict. # direct brokerage: purchasing goods and services that directly benefit the client ______________________________

Define direct brokerage

client directs manager to use his brokerage to purchase goods or services that benefit him # soft commissions ______________________________

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Explain the policies stating duties to client (10)

1. follow applicable laws 2. establish IPS, investment objectives of client 3. diversy to limit risk 4. no favoritism 5. disclose conflicts of interest 6. disclose compensation arrangements 7. vote proxies/shares in best interest of client 8. confidentiality 9. seek best execution 10. client interest first ______________________________

what is more important when communicating with clients: initial recommendation or change of recommendation?
change of recommendation ______________________________

who should be informed of recommendations first: firm or customer?

both simultaneously, and all customers simultaneously (maintain list of asset holders for that purpose) ______________________________

how many people should be privy to the fact that a recommendation is about to be disseminated?
as few as possible ______________________________

how long should the timeframe between recommendation decision and dissemination be?
as short as possible. beware: pending disseminations may be at risk of being discussed or acted upon. ______________________________
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investing client's assets: trade allocation and allocation procedures should be... 4
fair and equitable allocation (FIFO - first in, first out), and allocation procedures should be written and disclosed ______________________________

levels of service should be disclosed to...

all clients non-selectively ______________________________

Explain the compliance procedure for suitability for individual clients under III (c) (4)
1. client identification: name, age, occupation. type and nature of client, existence of separate beneficiaries, approx. portion of total client assets 2. investor objectives: return objectives (income, growth, cashflow), risk tolerance 3. investor constraints: liquidity needs, expected cashflow, investable funds, time horizon, taxes, legal considerations, investor preferences 4. performance measurement benchmarks ______________________________

IPS, definition, should include (4)

IPS = investment policy statement should include all data used to determine suitability under III (c) roles and responsibilities to advisory relationship and investment process schedules for review and evaluation clear understanding of the level of risk the client is willing to accept (in the context of the client's return requirements and objectives)

______________________________

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How often should client needs and circumstances be evaluated for the IPS?
At least once a year, or before any specific recommendation or decision on behalf of client. ______________________________

Exaplain compliance procedure for suitability for institutional clients under III (c) (3)
1. magnitude of unfunded liabilities in pension plan 2. withdrawal privileges in employee's savings plan 3. distribution requirements in charitable fund ______________________________

what is necessary to assess suitability completely and accurately?

full disclosure of client if not available, act on information supplied ______________________________

Explain the compliance procedure for III (d), performance presentation (5)
consider knowledge, sophistication of audience present weighted composite of similar portfolios and not just one model portfolio include terminated accounts include disclosures (performance gross/net of fees, after tax etc.) maintain records

______________________________

What if a performance was earned while at another firm? Can it be used for advertising?
it can be stated, but needs to be disclosed as earned at another firm ______________________________

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may fellow employees be informed about confidential client information?

generally, no, only if: they are authorized required by law client is involved in illegal activity

______________________________

what if a money manager suspects a client to commit illegal activities?

he should seek counsel with his firm's compliance department if he knows the client commits illegal activities, he should consult his supervisor. ______________________________

when leaving an employer, do not engage in ... (5)

1. misappropriation of trade secrets 2. misuse of confidential information 3. solicitation of employer's clients prior to cessation of employment 4. self-dealing (using business opportunities for oneself) 5. misappropriation of clients and client lists ______________________________

are skills and experience confidential once an employee has left a firm?
no, not confidential or privileged ______________________________

are client names confidential once an employee has left a firm?

no, unless deemed so by written agreement. contact information is confidential. ______________________________

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are files/records stored on a home computer for research confidential once an employee has left a firm?
such files should be erased or returned to the employer, unless otherwise permitted by employer. client contact information, computer models, files etc. are property of the employer but in general, knowledge or experience gained at one employer can be transferred to another employer and is not proprietary ______________________________

In which cases can a former employee contact former clients? (2)

If the contact information does not come from the records of the former employer If that would not violate an applicable non-compete agreement

______________________________

when can whistleblowing be seen as not violating IV (a), duties to employer? (3)
when it protects clients when it protects the market not for personal gain

______________________________

which forms of contracts are legally binding between employee/independent contractor and client?
oral and written agreements ______________________________

whose property are client records?

they are property of the firm ______________________________

why should the code of ethics and compliance procedures be separated?

to communicate clearly, devoid of legal terminology

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______________________________

What are the compliance procedures (9) for Standard IV (C)?

IV (C), Duties to Employer, Responsibility of Supervisors. Create and disseminate code manual Use easy to understand language Designate compliance officer Assign duties among supervisors Implement system of checks and balances Outline scope of procedures Outline procedures to monitor compliance procedures Outline permissible conduct Outline procedures for reporting violation

______________________________

once a compliance program is in place a supervisor should (7)

1. disseminate contents 2. periodically update procedures 3. continually educate personnel 4. issue periodic reminders 5. incorporate professional conduct evaluation in performance evaluation 6. review actions to identify violators 7. enforce procedures upon violation ______________________________

once a violation is discovered, a supervisor should (3)

1. respond promptly 2. determine scope of wrongdoing 3. increase supervision or place limitations on wrongdoer pending outcome of investigation ______________________________

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Explain compliance procedures V(a), diligence and reasonable basis in investment analysis (3)
1. establish policy requiring reports to have reasonable and adequate basis 2. written due diligence procedures for analysts for judging basis 3. develop measurable criteria for quality assessment of research ______________________________

Explain the criteria for assessing reasonable, sound basis of research (4)
rigor of analysis performed review of assumptions used data/timelines evaluation of objectivity and independence

______________________________

how can records be maintained?

electronic or in hard copy ______________________________

how long must records be maintained?

the recommendation is 7 years, but it is not a requirement ______________________________

when is it acceptable for a manager or advisor to profit from personal investments? standard VI (b) (3)
client is not disadvantaged by trade no personal profit from trades undertaken for clients (this would distort objectivity) applicable regulatory requirements are observed

______________________________

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Describe the hierarchy of transactions

client > employer > employee or his relatives, friends (non-clients) ______________________________

Describe the reporting requirements of private holdings under VI (b) (3)

1. yearly disclosure of holdings, as soon as employment commences 2. duplicate trade confirmations from broker to employee and employer 3. preclearance procedures of all personal investments ______________________________

may a candidate use partial CFA designation, such as CFA level I?

no, he may however state that he is a candidate if that is true ______________________________

is "CFA" an adjective or a noun?

always an adjective "john smith is a CFA" is improper. "john smith, CFA" is OK ______________________________

can the CFA logo be used for a company name?

no, only next to an individual ______________________________

who can comply with the GIPS standard?

any firm (distinct business entity) which manages assets, not individual consultants ______________________________

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Define a composite under GIPS. what must it include?

aggregation of all actual, fee-paying, discretionary portfolios managed in accordance with the same investment objective or strategy. # no subjective selection of included accounts ______________________________

Describe the verification criteria for GIPS compliance (3)

firm-wide compliance, whether the investment firm has complied with all the composite construction requirements of GIPS firm-wide. if a unit of a business conglomerate is a selfcontained firm, the owning firm must not comply with GIPS in order for the independent firm to be able to comply calculation and presentation methods, whether the firm's processes and procedures are designed to calculate and present performance results in compliance with GIPS. asset weighted average of the composites. verified/audited by independent third party -> credibility. encouraged, but not mandatory.

______________________________

what does GIPS stand for?

global investment performance standards measures investment performance. ______________________________

Why are GIPS needed (2)?

Fair, globalized competition leads to equal comparison, no barriers to entry for new investment firms, "GIPS passport" creates level playing field. Notion of self-regulation on global basis

______________________________

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what is the minimum of the historical performance record under GIPS to claim compliance?
5 years of compliant performance presentation. if the firm is younger than 5 years, GIPS requires performance records since inception. ______________________________

Describe the basic elements for presenting performance information under GIPS (8)
0. fundamentals of compliance: definition of the firm, total firm assets 1. input dat foundation for full, fair and comparable presentations 2. calculation methodology: uniformity of methods for portfolios and composites 3. composite construction: asset-weighted return -> consistency, comparability 4. disclosures: policies, static information 5. presentations and reporting: also include non-GIPS-compliant information 6. real estate: returns from land, buildings, structures etc. 7. private equity: includes fund-of-funds. NOT open-end or evergreen funds ______________________________

List the code of ethics (simplified, just keywords)

1. act with integrity 2. subordinate personal interest 3. use independent, professional, careful analysis 4. practice ethically 5. promote integrity 6. maintain and improve professional compentence

______________________________

Standard V(b), Communication with Clients and Prospective Clients requires ... (2)
prompt disclosure of any change that might significantly affect the managers investment processes The disclosure orally is sufficient, need not be in writing.

______________________________

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is an analyst allowed to use nonpublic information?

yes. analyst is allowed to (and is encouraged to) make use of nonpublic information under the mosaic theory, as long as the use of that information is in accordance with the standards (i. e. non-material). ______________________________

standard III c), suitability: are written documents required?

no, but the analyst must make a reasonable effort to inquire into a client's financial situation, investment experience, and risk and return objectives prior to making any investment recommendations ______________________________

additional compensation arrangements must be disclosed to whom? in writing/orally?

to supervisors in writing, only if there is reasonable conflict to be expected not to clients and not only orally ______________________________

is risk tolerance assessed in the IPS?

no, but it is under suitability. but: Tax concerns Expected cash flow patterns Liquidity needs ______________________________

which is a more serious violation of the CFA standards: accepting gifts from an existing client or from a non-client? why?
accepting a gift from a non-client is a more serious violation than accepting a gift from a client (for which a compensation arrangement would already exist), since the intent is almost certainly to gain influence over future actions of the member (e.g., increased allocation of trades). ______________________________

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identifying other clients for an investment falls under Standard ...

III(B), Fair Dealing ______________________________

According to Standard ..., members should only accept the use of corporate aircraft of a company being researched if ...
I (B), Independence and Objectivity only permissible when commercial transportation is not available # NOT when commercial transportation is burdensome ______________________________

Standard III(B), Fair Dealing, acknowledges that dealing fairly does [always / not always] mean dealing equally, and different service levels are [not] allowed.
acknowledges that dealing fairly does not always mean dealing equally, and different service levels are allowed. advisor cannot fax, e-mail, or call all clients simultaneously. ______________________________

when a CFA member feels a law has been violated, he should report to ..., when he knows a law has been violated he should report to ...
Standard I(A) says that when a member feels a law has been broken, the member should seek advice from the firms counsel. If the member feels the advice is unbiased and competent, the member should follow it. If the member knows a law has been violated, the member should contact a supervisor. ______________________________

if a manager changes the investment process on a fund, does he need written permission of the investors prior to the change?
permission not in writing, but he needs to notify all clients promptly of the change. ______________________________
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are analysts allowed to accept payment, transportation, lodging and meals for writing a report?
yes, but such arrangements need to be disclosed in the report. ______________________________

is presentation of individual account performance permitted under the CFA standards? what is the minimum of years that needs to be presented?
permitted under CFA, but it is not permitted under GIPS there is no minimum of years under the CFA standards, but GIPS requires 5 years. ______________________________

when including fund performance results in a brochure for clients, do these have to be audited?
no, neither in compliance with GIPS. they should be fair and accurate. ______________________________

when a member does not concur with the recommendation of a group, what should he do?
if there is reasonable basis for the recommendation, and a member does not agree with it, he need not dissociate from the recommendation, but should document the difference of opinion. ______________________________

GIPS standards: when must accounts be assigned to a composite?

before their returns are known, not after. assigning accounts at the end of the period (when returns are known) is unacceptable. ______________________________

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GIPS standards: composite returns must be ... weighted

asset weighted, not equal weighted. ______________________________

Are CFA candidates allowed to discuss specific questions from previous exams taken with future test takers?
No. ______________________________

is it conform with the standards to implement a recommendation action of the research department to all accounts?
no. standard III c), suitability, states accounts must be differentiated regarding the needs and constraints of each client and cannot be treated in the same way (unless suitable). ______________________________

may confidential client information be disclosed to the CFA institute professional conduct program?
Yes

CFA Level 1: Ethical and Professional Standards If you have any questions, email me at [email protected]. I wish you all the best for the CFA Exam!

Andy Solnik | http://www.financialanalystexam.com

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