CFA level 1 study notebook1 2015

Study Session 1Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook Onceaninquiry has begun, the Professional Conduct staffmayrequestinwritinganexplanat

BOOK 1 - ETHICAL AND PROFESSIONAL

METHODS

Reading Assignments and Learning OutcomeStatements 9

StudySession 1-Ethical and Professional Standards 15

Self-Test-Ethical and Professional Standards 95

StudySession2- QuantitativeMethods:BasicConcepts 102

StudySession 3 - QuantitativeMethods: Application 251

SCHWESERNOTES™ 2015 CFALEVEL I BOOK 1:ETHICALANDPROFESSIONALSTANDARDSANDQUANTITATIVE METHODS

©2014 Kaplan,Inc.All rightsreserved

Publishedin2014 by Kaplan,Inc

Printedinthe UnitedStatesofAmerica

ISBN:978-1-4754-2756-1/1-4754-2756-5

PPN:3200-5522

If this book does not have the hologram with the Kaplan Schweser logo on the back cover, it was

distributed without permission of Kaplan Schweser, a Division of Kaplan, Inc., and is in direct violation

of global copyright laws Your assistance in pursuing potential violators of this law is greatly appreciated.

Required CFA Institute disclaimer: “CFA Institute does not endorse, promote, or warrant the accuracy

or quality of the products or services offered by Kaplan Schweser.CFA®and Chartered Financial

Analyst® are trademarks owned by CFA Institute.”

Certain materials contained within this text are the copyrighted property of CFA Institute The following is the copyright disclosure for these materials: “Copyright, 2014, CFA Institute Reproduced and republished from 2015 Learning Outcome Statements, Level I, II, and III questions fromCFA®

Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute’s Global Investment Performance Standards with permission from CFA Institute All Rights Reserved.”

These materials may not be copied without written permission from the author The unauthorized duplication of these notes is a violation of global copyright laws and the CFA Institute Code of Ethics.

Your assistance in pursuing potential violators of this law is greatly appreciated.

Disclaimer: The Schweser Notes should be used in conjunction with the original readings as set forth

by CFA Institute in their 2015 CFA Level I Study Guide The information contained in these Notes

covers topics contained in the readings referenced by CFA Institute and is believed to be accurate.

However, their accuracy cannot be guaranteed nor is any warranty conveyed as to your ultimate exam success The authors of the referenced readings have not endorsed or sponsored these Notes.

WELCOME TO THE 2015

SCHWESERNOTES™

Thankyoufor trusting Kaplan Schwesertohelpyoureachyourgoals.Weareallvery

pleased tobeabletohelpyoupreparefor theLevel I CFAExam.In thisintroduction,

Iwant toexplainthe resourcesincludedwith theSchweserNotes, suggesthow you

canbest useSchweser materialstoprepare fortheexam,and directyoutowardother

educationalresourcesyouwill find helpfulasyoustudy for theexam.

Besides the SchweserNotesthemselves,therearemanyeducationalresourcesavailableat

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whenyoupurchasedthe SchweserNotes.Most candidates findourOnlineResource

Library video “HowtoPass the Level ICFA Exam”veryhelpfulin bothplanning and

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SchweserNotes™

Theseconsistof five volumes that include completecoverageof all18StudySessions

andall LearningOutcome Statements(LOS)with examples, Concept Checkers

(multiple-choicequestions for every topicreview),andChallengeProblemsfor many

topic reviewstohelpyoumasterthe materialandcheck yourprogress.At theendof

eachmajor topicarea, weincludeaSelf-test Self-testquestionsarecreatedto beexam¬

likeinformat and difficultyinorderforyoutoevaluate how wellyourstudy of each

topichaspreparedyouforthe actualexam.

Practice Questions

Toretainwhat you learn,it isimportant that you quizyourselfoften We offer online

andoffline versions ofthe SchweserPro QBank, whichcontainsthousandsofLevelI

practicequestions and explanations.Quizzesareavailableforeach LOS,topic,orStudy

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Schweserofferssixfull 6-hourpracticeexams PracticeExamsVolume1and Volume2

each contain threefull 240-questionexams Theseareimportant tools forgainingthe

speed and skillsyouwill needtopasstheexam.Each bookcontainsanswerswith full

explanations for self-grading and evaluation By enteringyouranswers atSchweser.com,

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Wehave createdreferencevideos,someof whichareavailabletoall SchweserNotes

purchasers Schweser Library volumesaretypically between20and 60minutes inlength

andcoversuch topicsas:“CFALevelI ExamOverview,”“CalculatorBasics,”“Codeand

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Online SchweserStudy Calendar

Welcome to the2015SchweserNotes™

breaking each studysession intodaily and weekly taskstokeepyouontrack and help

youmonitor your progressthrough thecurriculum

The LevelI CFAexamisaformidable challenge(63topicreviewsandmorethan 500Learning OutcomeStatements),andyou mustdevoteconsiderabletimeand effort

tobeproperlyprepared.Thereis noshortcut!Youmustlearn thematerial,know theterminology and techniques, understand theconcepts,and be ableto answer240questions quickly and(atleast70%)correctly Fifteento20hoursperweekfor20weeks

isagoodestimateof the studytimerequiredonaverage,butsomecandidateswill need

more orlesstime,dependingontheirindividual backgrounds andexperience

Tohelpyoumasterthis material and be wellpreparedfor the CFAExam, weofferseveral other educationalresources,including:

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Weoffer weekly classroomprogramsaroundtheworld PleasecheckSchweser.comforlocations, dates,and availability

Online ClassOurOnline ClassesareavailableatNewYorktime(6:30-9:30pm)orLondontime

(6:00—9:00pm) beginninginJanuaryandJuly.The approximateschedulefor the Level IOnline Classes(3-hour sessions)isasfollows:

1 Exam Intro/Quantitative Methods SS2 9 Financial Reporting & Analysis SS10

2 Quantitative Methods SS3 10CorporateFinance SS11

3 Economics SS4,5 11 Equity Investments SS13,14

4Economics SS5, 6 12 Fixed Income SSI5

5Financial Reporting & Analysis SS7 1 3 Fixed Income SS16

6 Financial Reporting & Analysis SS8 14 Derivatives SSI 7

15Portfolio Management & Alternative Investments SSI 2, 18

7 Financial Reporting & Analysis SS8, 9

8 Financial Reporting & Analysis SS9Archivedclassesareavailablefor viewingatanytimethroughouttheseason.Candidatesenrolledinthe Online Classesalsohave fullaccess tosupplemental on-demand videoinstruction inthe Schweser Library andane-mail addressto use tosend questionstotheinstructoratany time

Late Season ReviewWhetheryou useself-studyorin-class, online,orvideo instructiontolearnthe CFA

curriculum, alate-seasonreviewandexampracticecanmake all thedifference Our

mostcomplete late-seasonreviewcourse isourresidenceprogram in Windsor, Ontario(WindsorWeek)wherewe covertheentirecurriculumover sevendays (May2-8, 2015)

atallthree levels.Weoffer3-Day LiveExamReviewWorkshopsin many cities (and

online)that combinecurriculumreviewwithanequalcomponentof hands-on practicewithhundredsof questionsand problem-solving techniques.We also offer Exam ReviewWorkshopsina5-day formatinDallas/Fort Worth andNew York.Pleasevisitus at

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offerings

Mock Examand Multimedia Tutorial

The Schweser Mock Exam will be offered liveinover100locations around the worldin

late Mayand late November,andas anonlineexam aswell.The included ExamTutorial

providesextendedexplanations and topictutorialsto get youexam-readyin topicareas

whereyoumissquestionsontheMock Exam.Pleasevisit Schweser.com foralistingof

citiesand locations

Topic Weighting

In preparing fortheexam,youmustpayattention totheweights assignedtoeach topic

within the curriculum.TheLevelI topicweightsare asfollows:

ExamWeight

Topic Ethical and Professional Standards 15%

Thereare noshortcuts;dependonthefact that CFAInstitutewilltestyou inaway

that will reveal how wellyouknow the LevelIcurriculum.Youshould begin early and

sticktoyourstudy plan.Youshould first read the SchweserNotes and complete the

ConceptCheckersandChallengeProblemsfor each topic review You should prepare

forand attendaliveclass, an online class,or astudygroup eachweek.Youshouldtake

quizzesoften using SchweserPro Qbank andgobacktoreview previous topicsand Study

Sessionsaswell.Atthe endof each topicarea, youshould take the Self-testtocheck

yourprogress You should finish the overall curriculumatleastfour weeks(preferably

longer)before theLevelIexam sothat youhave sufficienttimeforPracticeExamsand

forfurtherreview of those topics that you havenot yetmastered

IwouldliketothankCraigProchaska, CFA,ContentSpecialist,for hiscontributionsto

producing the LevelISchweserNotesfor theCFAExam

Bestregards,

“Dotty'Uatt Sato*

Dr.DouglasVanEaton,CFA

READING ASSIGNMENTS AND

Thefollowing materialisareviewofthe Ethical andProfessionalStandards and

QuantitativeMethodsprinciples designedtoaddress the learningoutcome statements setforth

byCFAInstitute

STUDY SESSION l

Reading Assignments

Ethical andProfessionalStandardsandQuantitative Methods, CFAProgram Level I2015

Curriculum,Volume1(CFAInstitute,2014)

1 Codeof Ethics and Standards of Professional Conduct

2 Guidance for Standards I-VII

3 Introductiontothe Global InvestmentPerformance Standards(GIPS®) page 85

page 87

page15page15

4 The GIPS Standards

STUDY SESSION 2

Reading Assignments

Ethical andProfessionalStandards andQuantitative Methods,CFAProgram Level I2015

Curriculum,Volume1(CFAInstitute,2014)

5. TheTimeValueof Money

6 Discounted Cash Flow Applications

7 Statistical Concepts and Market Returns

8 Probability Concepts

page 102page143page 168page 207

STUDY SESSION 3

Reading Assignments

Ethical andProfessionalStandards andQuantitative Methods, CFAProgram Level 12015

Curriculum,Volume1(CFA Institute, 2014)

9 Common Probability Distributions

10.Sampling andEstimation

11 Hypothesis Testing

12.Technical Analysis

page 251

page287page310page 350

Book 1-Ethical and ProfessionalStandardsand Quantitative Methods

ReadingAssignments and Learning Outcome Statements

LEARNINGOUTCOME STATEMENTS (LOS)

STUDY SESSION l

The topical coverage corresponds with thefollowing CFAInstituteassigned reading:

1 Codeof Ethics and Standards of Professional ConductThe candidate should be ableto:

a. describe thestructureof the CFAInstituteProfessional Conduct Programandthe process for the enforcement of the Code andStandards,(page15)

b statethesixcomponentsof the Code of Ethics and thesevenStandardsofProfessionalConduct,(page16)

c. explain the ethical responsibilities required by the Code andStandards,including the sub-sections of eachStandard,(page17)

2 Guidancefor StandardsI-VIIThe candidate should be ableto:

a. demonstrate the application of the Code of Ethics and Standards of ProfessionalConducttosituationsinvolvingissuesof professional integrity, (page20)

b distinguish between conduct that conformstothe Code and Standards andconduct that violates the Code andStandards,(page20)

c. recommend practices and procedures designedto preventviolationsof the Code

of Ethics and Standards of ProfessionalConduct,(page20)

3 IntroductiontotheGlobalInvestmentPerformance Standards (GIPS®)The candidate should be ableto:

a. explain why theGIPSstandardswerecreated,what parties the GIPS standardsapplyto,and whoisserved by thestandards,(page85)

b explain theconstructionandpurposeof compositesinperformance reporting

(page86)

c. explain the requirements forverification,(page86)

4 TheGIPSStandardsThe candidate should be ableto:

a. describe the key features of the GIPS standards and the fundamentals ofcompliance, (page87)

b describe thescopeof theGIPSstandards withrespect to aninvestmentfirm’sdefinition and historicalperformancerecord,(page89)

c. explain how the GIPS standardsareimplementedincountrieswith existingstandardsfor performance reporting and describe the appropriate response whentheGIPSstandards and local regulationsconflict,(page89)

d describe thenine major sectionsof theGIPSstandards,(page89)

b explainan interestrate asthesumofarealrisk-freerate,andpremiumsthat

compensateinvestorsfor bearing distincttypesofrisk,(page105)

c. calculate and interpret the effective annualrate,given the stated annualinterest

rateand thefrequency of compounding, (page105)

Book 1 -Ethical andProfessionalStandardsandQuantitativeMethods

ReadingAssignments and Learning Outcome Statements

d solvetimevalueofmoneyproblems for different frequencies of compounding

(page107)

e calculate and interpret the future value(FV)andpresentvalue(PV)ofasingle

sumofmoney, anordinary annuity,anannuitydue,aperpetuity (PVonly), and

aseriesof unequal cashflows,(page108)

f demonstrate theuseofatimelineinmodeling and solvingtimevalue ofmoney

problems, (page123)

6 Discounted Cash Flow Applications

The candidate should be ableto:

a. calculate and interpret thenet presentvalue(NPV)and the internalrateof

return (IRR)ofan investment,(page143)

b contrastthe NPV ruletothe IRRrule,andidentify problems associated with

theIRRrule,(page146)

c. calculate and interpretaholding periodreturn(total return),(page148)

d calculate andcomparethe money-weighted and time-weightedratesofreturnof

aportfolio and evaluate the performance of portfolios basedonthesemeasures

(page148)

e. calculate and interpret the bank discount yield, holding period yield, effective

annual yield, andmoneymarket yield for USTreasury bills and othermoney

marketinstruments,(page152)

f convertamongholdingperiod yields,moneymarket yields, effective annual

yields, and bond equivalent yields, (page155)

7 Statistical Concepts and MarketReturns

The candidate should be ableto:

a. distinguishbetween descriptivestatisticsand inferentialstatistics,between

apopulation andasample, and among thetypesofmeasurementscales

(page168)

b definea parameter, asamplestatistic,andafrequencydistribution,(page169)

c. calculate and interpret relative frequencies and cumulative relative frequencies,

givenafrequencydistribution,(page171)

d describe the properties ofadatasetpresentedas ahistogramorafrequency

polygon, (page174)

e. calculate and interpretmeasuresof central tendency, including the population

mean,samplemean,arithmeticmean,weightedaverageormean,geometric

mean,harmonicmean,median,andmode,(page175)

f calculate and interpret quartiles, quintiles,deciles,and percentiles, (page180)

g calculate and interpret1)arangeanda meanabsolute deviation and2)the

varianceand standard deviation ofapopulation and ofasample, (page181)

h calculate and interpret the proportion of observations falling withinaspecified

numberof standard deviations of themeanusing Chebyshev’sinequality

k describe the relative locations of themean,median,and mode foraunimodal,

nonsymmetricaldistribution,(page189)

1 explainmeasuresof sample skewness and kurtosis (page190)

m compare theuseof arithmetic and geometricmeanswhen analyzinginvestment

Book 1-Ethical and ProfessionalStandardsand Quantitative Methods

ReadingAssignments and Learning Outcome Statements

8 Probability ConceptsThe candidate should be ableto:

a. definearandomvariable, anoutcome,anevent,mutually exclusiveevents,andexhaustiveevents,(page207)

b statethetwodefining properties of probability and distinguish among empirical,subjective, andaprioriprobabilities, (page207)

c statethe probability ofaneventintermsof odds for and against theevent.

(page208)

d distinguish between unconditional and conditional probabilities, (page209)

e. explain the multiplication,addition,and total probabilityrules,(page209)

f calculate and interpret1)the joint probability oftwo events,2)the probabilitythatatleastoneoftwo eventswilloccur,given the probability of each and thejointprobability of thetwo events,and3)ajointprobability ofanynumberofindependentevents,(page210)

g distinguish between dependent and independentevents,(page213)

h calculate and interpretanunconditional probability using the total probability

rule,(page214)

i explain theuseof conditional expectationin investmentapplications, (page218)

j explain theuseofa treediagramto represent aninvestmentproblem, (page218)

k calculate and interpretcovarianceandcorrelation,(page219)

1 calculate andinterpretthe expectedvalue,variance,and standard deviationofa

random variable andofreturnsonaportfolio, (page223)

m calculate and interpretcovariancegivenajointprobabilityfunction,(page224)

n. calculate and interpretanupdated probability using Bayes’formula, (page228)

o. identify themostappropriate methodtosolveaparticular counting problem,and solve counting problems usingfactorial, combination,andpermutation

c interpretacumulative distributionfunction,(page253)

d calculate and interpret probabilities forarandomvariable,givenitscumulativedistributionfunction,(page253)

e. defineadiscrete uniform randomvariable,aBernoulli randomvariable,anda

binomial randomvariable,(page 254)

f calculate and interpret probabilities given the discrete uniform and the binomialdistributionfunctions,(page254)

g construct abinomialtree todescribe stock pricemovement,(page257)

h calculate and interpret trackingerror,(page259)

i define thecontinuousuniform distribution and calculate and interpretprobabilities, givenacontinuousuniformdistribution,(page259)

j explain the key properties of the normaldistribution,(page261)

k distinguish betweenaunivariateandamultivariatedistribution,and explain theroleof correlationinthe multivariate normaldistribution,(page261)

Book 1 -Ethical andProfessionalStandardsandQuantitativeMethods

ReadingAssignments and Learning Outcome Statements

1 determine the probability thatanormally distributed random variable lies inside

agiveninterval,(page262)

m. define the standard normaldistribution,explain howtostandardizearandom

variable,and calculate and interpret probabilities using the standard normal

distribution,(page264)

n. define shortfallrisk,calculate the safety-firstratio,and selectanoptimal

portfolio using Roy’s safety-firstcriterion,(page267)

o. explain the relationship between normal and lognormal distributions and why

the lognormal distributionisusedtomodelassetprices, (page269)

p distinguish between discretely and continuouslycompoundedratesofreturn,

and calculate and interpretacontinuously compoundedrateofreturn,givena

specificholdingperiodreturn,(page270)

q explainMonteCarlo simulation and describeitsapplications and limitations

(page272)

r compareMonteCarlo simulation and historicalsimulation,(page273)

10 Sampling andEstimation

The candidate should be ableto:

a. define simple random sampling andasamplingdistribution,(page287)

b explain samplingerror,(page287)

c. distinguish between simple random and stratified random sampling, (page288)

d distinguish betweentime-seriesand cross-sectionaldata,(page289)

e. explain the central limit theorem anditsimportance,(page289)

f calculate and interpret the standarderrorof the samplemean,(page290)

g identify and describe desirable properties ofanestimator,(page292)

h distinguish betweenapointestimateandaconfidence intervalestimateofa

populationparameter,(page292)

i. describe properties of Student’s t-distribution and calculate and interpretits

degrees offreedom,(page292)

j calculate and interpretaconfidence intervalforapopulationmean,givena

normal distribution with1)aknown populationvariance,2)anunknown

populationvariance,or3)anunknownvarianceandalargesamplesize

(page294)

k describe theissuesregarding selection of the appropriate samplesize,

data-miningbias,sample selectionbias,survivorshipbias,look-aheadbias,and

time-periodbias,(page299)

11.Hypothesis Testing

The candidate should be ableto:

a. defineahypothesis, describe thestepsof hypothesis testing, and describe and

interpret the choice of the null and alternative hypotheses, (page310)

b distinguish between one-tailed and two-tailedtestsofhypotheses, (page311)

c. explaina test statistic,TypeIandTypeIIerrors, asignificancelevel,and how

significance levelsareusedinhypothesis testing, (page315)

d explainadecisionrule,thepowerofa test,and the relation between confidence

intervals and hypothesistests,(page 317)

e. distinguish betweenastatistical result andaneconomically meaningful result

(page319)

f explain and interpret the /)-valueasitrelatestohypothesis testing, (page320)

g identify the appropriateteststatisticand interpret the results forahypothesis

testconcerning the populationmeanof both large and small samples when

Book 1-Ethical and ProfessionalStandardsand Quantitative Methods

ReadingAssignments and Learning Outcome Statements

h identify the appropriateteststatisticand interpret the results forahypothesis

testconcerning the equality of thepopulationmeansoftwo atleastapproximately normally distributed populations, basedonindependent randomsamples with1)equalor 2)unequal assumedvariances,(page324)

i identify the appropriateteststatisticand interpret the results forahypothesis

testconcerning themeandifferenceoftwonormally distributed populations

(page328)

j identify the appropriateteststatisticand interpret the results forahypothesis

testconcerning1)thevarianceofanormally distributed population, and2)theequality of thevariancesoftwonormally distributed populations basedon two

independent random samples, (page332)

k distinguishbetween parametric and nonparametrictestsanddescribesituations

inwhich theuseof nonparametrictestsmaybe appropriate, (page339)

12.Technical AnalysisThe candidate should be ableto:

a. explain principles of technical analysis,itsapplications, anditsunderlyingassumptions,(page350)

b describe theconstructionof differenttypesof technical analysis charts andinterpretthem,(page351)

c explainusesoftrend,support,resistance lines,and changeinpolarity

(page354)

d describecommonchartpatterns,(page355)

e. describecommontechnical analysis indicators (price-based,momentum

oscillators,sentiment,and flow offunds),(page357)

f explain how technical analystsusecycles, (page362)

g describe the keytenetsof ElliottWaveTheory and theimportanceof Fibonacci

numbers,(page362)

h describe intermarket analysisasitrelatestotechnical analysis andasset

allocation,(page363)

The following is a review of the Ethical and Professional Standards principles designed to address the

learning outcome statements set forth by CFA Institute This topic is also covered in:

Study Session 1

EXAMFOCUS

Inadditiontoreading thisreviewof the ethicsmaterial,westrongly recommend that

all candidates for theCFA®examinationread the StandardsofPracticeHandbook 11th

Edition(2014)multipletimes.AsaLevel I CFAcandidate, it is yourresponsibilityto

comply with the Code and Standards The complete Code and Standardsarereprintedin

Volume1of the CFAProgramCurriculum

LOSl.a:Describe thestructureof the CFAInstituteProfessional Conduct

Program and the process for the enforcement of the Code and Standards

CFA®ProgramCurriculum, Volume1,page 9The CFAInstituteProfessional Conduct Programiscovered by the CFAInstitute

Bylaws and the Rules of Procedure for Proceedings RelatedtoProfessional Conduct The

Programisbasedonthe principles of fairness of theprocesstomembers and candidates

and maintaining the confidentiality of the proceedings The DisciplinaryReview

Committeeof the CFAInstituteBoardof Governors has overall responsibility for the

Professional Conduct Program and enforcement of the Code and Standards

The CFAInstituteProfessional Conductstaff conducts inquiries relatedtoprofessional

conduct Severalcircumstancescan promptsuchaninquiry:

1. Self-disclosure by membersorcandidatesontheir annual Professional Conduct

Statementsof involvementincivil litigationoracriminal investigation,orthat the

memberorcandidateisthe subject ofawrittencomplaint

2 Writtencomplaints aboutamemberorcandidate’s professional conduct thatare

received by the Professional Conduct staff

3 Evidence of misconduct byamemberorcandidate that the Professional Conduct

staff receivedthroughpublicsources,suchas amedia articleorbroadcast

4 AreportbyaCFAexam proctorofapossible violation during theexamination

5 Analysis ofexammaterials and monitoring of social media by CFAInstitute

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Onceaninquiry has begun, the Professional Conduct staffmayrequest(inwriting)anexplanation from the subject memberorcandidate andmay: (1) interviewthe subjectmemberorcandidate,(2)interviewthe complainantorother third parties, and/or

(3)collect documents and records relevanttothe investigation

The Professional Conductstaffmaydecide:(1)thatnodisciplinarysanctions areappropriate,(2)toissueacautionary letter, or (3)todiscipline the memberorcandidate Ina casewhere the Professional Conductstaff findsaviolation has occurredandproposesadisciplinarysanction,the memberorcandidatemayaccept orrejectthesanction.If the memberorcandidate choosestoreject thesanction,thematterwill bereferredto adisciplinaryreviewpanel of CFAInstitutemembersforahearing.Sanctionsimposedmayinclude condemnation by the member’s peersorsuspension of candidate’scontinued participationinthe CFA Program

LOS l.b:Statethesixcomponentsof the Code of Ethics and theseven

Standardsof Professional Conduct

CFA®ProgramCurriculum,Volume1,page15

CODEOFETHICS

MembersofCFA Institute[including Chartered FinancialAnalyst®(CFA®)

charterholders]and candidates for the CFA designation (“MembersandCandidates”)

must:1

• Actwith integrity,competence,diligence,respect,andinanethicalmannerwiththe public,clients,prospectiveclients,employers, employees, colleaguesintheinvestmentprofession, and other participantsinthe global capital markets

• Place the integrity of theinvestmentprofession and theinterestsof clients abovetheirownpersonalinterests

• Usereasonablecareandexerciseindependent professional judgment whenconductinginvestmentanalysis, makinginvestment recommendations,takinginvestmentactions,and engaginginother professionalactivities

• Practiceand encourage otherstopracticeinaprofessional and ethicalmannerthatwill reflect creditonthemselves and the profession

• Promotethe integrity and viability of the global capital markets for the ultimatebenefitof society

• Maintainand improve their professionalcompetenceandstrivetomaintainandimprove thecompetenceof otherinvestmentprofessionals

THE STANDARDSOFPROFESSIONAL CONDUCT

ProfessionalismIntegrity of Capital MarketsDutiestoClients

DutiestoEmployersInvestmentAnalysis,Recommendations,andActionsConflictsofInterest

Responsibilitiesas aCFAInstituteMemberorCFACandidate

IIIIIIIVVVIVII

1. Copyright2014,CFAInstitute.Reproduced and republished from “The Code ofEthics,”

from StandardsofPractice Handbook,11thEd., 2014,withpermission fromCFAInstitute.

All rights reserved

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

LOSl.c:Explainthe ethicalresponsibilities required bythe Code and

Standards,includingthe sub-sections of each Standard

CFA®Program Curriculum, Volume1,page 15

STANDARDSOFPROFESSIONAL CONDUCT2

I PROFESSIONALISM

A Knowledge of theLaw.Members and Candidatesmustunderstand and

comply with all applicablelaws, rules,and regulations (including the CFAInstituteCodeofEthics and StandardsofProfessionalConduct)ofany

government,regulatory organization, licensing agency,orprofessionalassociationgoverning theirprofessionalactivities.In theeventofconflict,Members and Candidatesmustcomply with themorestrict law, rule,or

regulation.Members andCandidatesmust notknowinglyparticipateorassist

inanyviolationoflaws, rules, orregulations andmustdisassociate themselvesfromanysuch violation

B Independence and Objectivity Members and Candidatesmust usereasonable

careand judgmenttoachieve andmaintainindependence and objectivityintheir professionalactivities.Members and Candidatesmust notoffer, solicit, or

acceptanygift,benefit,compensation,orconsideration that reasonably could

be expectedtocompromise theirownoranother’s independence andobjectivity

C Misrepresentation Members and Candidatesmust notknowingly makeany

misrepresentations relatingtoinvestmentanalysis,recommendations,actions,

orother professionalactivities

D Misconduct Members and Candidatesmust notengage in anyprofessional

conduct involving dishonesty,fraud,ordeceitorcommit anyactthat reflectsadverselyontheir professional reputation, integrity,orcompetence.

II. INTEGRITYOFCAPITAL MARKETS

A MaterialNonpublic Information Members and Candidates whopossess

material nonpublic information that could affect the value ofan investment

must not act or causeothersto act onthe information

B Market Manipulation Members and Candidatesmust notengageinpractices

that distort pricesorartificially inflate trading volume with theintentto

mislead market participants

III DUTIESTO CLIENTS

A Loyalty,Prudence,and Care Members and Candidates haveaduty of loyalty

totheir clients andmust actwith reasonablecareandexerciseprudentjudgment Members and Candidatesmust actfor the benefit of their clientsand place their clients’interestsbefore their employer’sortheirowninterests

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

E B FairDealing Members and Candidatesmustdeal fairly and objectively with

all clients when providinginvestmentanalysis, makinginvestment

recommendations,takinginvestmentaction, orengaging in otherprofessional

activities.

C Suitability

1 WhenMembersand Candidatesareinanadvisoryrelationship witha

client,theymust:

a. Makeareasonableinquiryinto aclient’sorprospective clients’

investmentexperience, riskandreturnobjectives, andfinancialconstraints priortomakinganyinvestmentrecommendationortakinginvestment actionandmust reassessand update this informationregularly

b Determinethataninvestment issuitabletothe client’s financialsituationandconsistentwith the client’swrittenobjectives,mandates,andconstraintsbefore makinganinvestmentrecommendationor

takinginvestment action.

c. Judge the suitability ofinvestments inthecontextof the client’s totalportfolio

2. WhenMembersand Candidatesareresponsiblefor managingaportfolioto

aspecificmandate,strategy, orstyle, theymustmake onlyinvestmentrecommendationsortakeinvestment actionsthatareconsistentwith thestatedobjectives andconstraintsof theportfolio

D PerformancePresentation.When communicatinginvestmentperformanceinformation,MembersorCandidatesmustmake reasonableeffortsto ensure

thatit is fair,accurate,and complete

E Preservation ofConfidentiality.Membersand Candidatesmustkeepinformation aboutcurrent,former,and prospective clients confidential unless:

1 The informationconcernsillegalactivities onthepartof the clientor

prospective client,

2 Disclosureisrequired bylaw,or

3 Theclientorprospectiveclientpermitsdisclosureof theinformation

IV DUTIESTOEMPLOYERS

A Loyalty.Inmattersrelatedtotheir employment,Membersand Candidates

must actfor the benefit of their employer andnotdeprive their employer of theadvantage of their skills andabilities,divulge confidentialinformation,or

otherwisecauseharmtotheiremployer

B AdditionalCompensationArrangements Members and Candidatesmust not

acceptgifts,benefits,compensation,orconsideration thatcompeteswith,or

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

might reasonably be expectedto create aconflictofinterest with,theiremployer’sinterestunless they obtainwrittenconsentfrom all parties involved

C Responsibilities of Supervisors Members and Candidatesmustmake

reasonableeffortstoensurethatanyonesubjecttotheir supervisionorauthority complies with applicablelaws, rules,regulations, and the Code andStandards

V INVESTMENTANALYSIS,RECOMMENDATIONS, ANDACTIONS

A DiligenceandReasonableBasis.Members and Candidatesmust:

1. Exercisediligence, independence, and thoroughnessinanalyzing

investments,makinginvestment recommendations,and takinginvestmentactions

2 Haveareasonable and adequatebasis,supported by appropriate researchand investigation, forany investmentanalysis,recommendation,oraction

B Communication withClients andProspectiveClients Members and

in communicationswith clients and prospective clients

4 Distinguish between fact and opinioninthe presentation ofinvestmentanalysis and recommendations

C RecordRetention.Members and Candidatesmustdevelop andmaintain

appropriate recordsto supporttheirinvestmentanalysis,recommendations,

actions,and other investment-relatedcommunicationswith clients andprospective clients

VI CONFLICTSOFINTEREST

A Disclosure of Conflicts Members and Candidatesmustmake full and fair

disclosureof allmattersthat could reasonably be expectedtoimpair theirindependence and objectivityorinterfere with respective dutiestotheirclients,prospectiveclients,and employer Members and Candidatesmustensurethatsuch disclosuresareprominent,aredeliveredinplainlanguage,and

communicatethe relevant information effectively

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

B PriorityofTransactions.Investment transactionsfor clients and employers

musthave priorityoverinvestment transactions inwhichaMemberor

Candidateisthe beneficialowner.

C ReferralFees.Members and Candidatesmustdisclosetotheir employer,clients,and prospectiveclients,asappropriate,anycompensation,consideration,orbenefit receivedfrom,orpaidto,othersfor therecommendationof productsor services

VII RESPONSIBILITIESAS A CFAINSTITUTE MEMBEROR CFACANDIDATE

A ConductasParticipants inCFAInstitutePrograms Members and Candidates

must notengage in anyconduct that compromises the reputationorintegrity

of CFAInstituteorthe CFA designationorthe integrity, validity,orsecurity ofCFAInstituteprograms

B ReferencetoCFAInstitute,theCFADesignation, and the CFA Program

When referringtoCFAInstitute,CFAInstitutemembership, the CFAdesignation,orcandidacyinthe CFAProgram,Members and Candidatesmust

notmisrepresent orexaggeratethe meaningorimplications of membershipinCFAInstitute,holding the CFA designation,orcandidacyinthe CFAProgram

LOS2.a:Demonstratetheapplicationof the Code of Ethics and Standards ofProfessional Conducttosituationsinvolvingissuesofprofessionalintegrity

LOS2.b:Distinguishbetween conduct that conformstothe Code andStandardsand conduct that violates the Code and Standards

LOS2.c:Recommend practices andprocedures designedtopreventviolations

of the Code of Ethics and Standards of Professional Conduct

CFA®ProgramCurriculum,Volume1,page21Professionalism

Knowledge of theLaw.Members and Candidatesmustunderstand andcomply with all applicablelaws, rules,and regulations (including the CFAInstituteCode of Ethics and Standards of ProfessionalConduct)ofanygovernment,regulatoryorganization,licensing agency,orprofessionalassociationgoverning their professionalactivities Intheeventofconflict,Members and Candidatesmustcomply with the

morestrict law, rule,orregulation Members and Candidatesmust notknowinglyparticipateorassist in andmustdissociate fromanyviolationof suchlaws, rules,or

regulations

I1(A)

Professor’sNote:Whilewe usetheterm “members”inthefollowing,notethat all

ofthe Standards applytocandidatesaswell

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

Guidance—Code and Standardsvs.LocalLaw

Membersmustknow the laws and regulations relatingtotheir professionalactivities in

allcountries inwhich they conduct business Membersmustcomply with applicable

laws andregulations relatingtotheir professional activity.Donotviolate Codeor

Standardsevenif theactivity isotherwise legal Always adheretothemoststrictrules

and requirements(laworCFA Institute Standards)that apply

Guidance—ParticipationorAssociationWith Violations by Others

Members shoulddissociate, orseparatethemselves,fromanyongoing clientoremployee

activitythatisillegalor unethical, evenifitinvolves leavinganemployer(anextreme

case).Whileamembermayconfront the involved individualfirst,hemustapproach

his supervisororcompliance department.Inactionwith continuedassociation maybe

construedasknowing participation

Recommended ProceduresforCompliance—Members

• Members should have procedurestokeepupwith changesinapplicablelaws, rules,

and regulations

• Compliance procedures should be reviewedon anongoing basisto assurethatthey

addresscurrentlaw, CFAI Standards,and regulations

• Members shouldmaintaincurrentreference materials for employeesto accessin

ordertokeep uptodateon laws, rules,and regulations

• Members should seek adviceof counselortheir compliance department whenin

doubt

• Members should documentanyviolations when they disassociate themselves from

prohibited activity and encourage their employerstobringanendtosuch activity

• Thereisnorequirement under the Standardsto reportviolationstogovernmental

authorities,but thismaybe advisablein some circumstancesand required by lawin

others

• Membersarestronglyencouragedto reportother members’ violationsof the Code

and Standards

Recommended ProceduresforCompliance—Firms

Members should encourage their firmsto:

• Develop and/or adoptacode of ethics

• Make availabletoemployees information thathighlightsapplicable laws and

regulations

• Establishwrittenprocedures for reporting suspected violation oflaws,regulations,or

companypolicies

Members who supervise thecreationandmaintenanceofinvestment servicesand

products should beawareof and comply with the regulations and laws regarding such

servicesand products bothintheircountryof origin and thecountrieswhere they will

be sold

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

ApplicationofStandard1(A)KnowledgeoftheLaur’

Comment:

Althoughit isrecommended that members and candidates seek the advice of legalcounsel,the relianceonsuch advice doesnotabsolveamemberorcandidatefrom therequirementtocomply with the laworregulation Allen shouldreportthissituationto

his supervisor, seekanindependentlegalopinion, and determine whether theregulatorshould be notifiedof theerror

Example2:

Kamisha Washington’s firm advertisesitspastperformance record by showing theyearreturnofacomposite ofitsclientaccounts However,Washington discovers that thecompositeomitstheperformance ofaccountsthat have left the firm during the10-yearperiod and that thisomissionhas ledtoaninflatedperformance figure Washington

10-isaskedto usepromotional material that includes theerroneousperformance numberwhen soliciting business for the firm

Comment:

Misrepresentingperformanceisaviolationof the Code and Standards Although she did

notcalculate theperformanceherself,Washington would be assistinginviolating thisstandard if shewere to usethe inflatedperformance number when soliciting clients She

mustdissociate herselffrom the activity Shecanbring the misleading numbertotheattentionof thepersonresponsible for calculating performance, her supervisor,orthecompliance departmentather firm If her firmisunwillingtorecalculateperformance,shemustrefrainfrom using the misleading promotional material and should notifythe firmof herreasons.If the firminsiststhat sheusethematerial,she should considerwhether her obligationtodissociate from theactivitywould require hertoseek otheremployment

3 Ibid

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

Example 4:

LauraJameson,aU.S.citizen,worksforaninvestmentadvisor basedinthe United

Statesand worksina countrywhereinvestmentmanagersareprohibited from

participatingin IPOsfor theirown accounts.

Comment:

Jamesonmustcomply with thestrictestrequirementsamong U.S law(whereher firm

is based),the CFAInstituteCode andStandards,and the lawsof thecountrywhere she

isdoingbusiness In thiscasethatmeansshemust notparticipatein anyIPOsfor her

personalaccount.

Example 5:

Ajuniorportfoliomanagersuspectsthatabroker responsible fornewbusiness from

aforeigncountryisbeing allocatedaportion of the firm’spaymentsfor third-party

research andsuspectsthatnoresearchisbeing provided.Hebelieves that the research

paymentsmaybe inappropriate and unethical

Comment:

Heshould follow his firm’s procedures for reporting possible unethical behavior andtry

to getbetter disclosureof thenatureof thesepaymentsandanyresearch thatisbeing

provided

1(B) Independence and Objectivity Members and Candidatesmust usereasonable

careand judgmenttoachieve andmaintainindependence and objectivityintheir

professionalactivities Membersand Candidatesmust notoffer, solicit, oracceptany

gift,benefit,compensation,orconsideration that reasonably could be expectedto

compromise theirown oranother’s independence and objectivity

Guidance

Donotlet theinvestment processbe influenced byanyexternalsources.Modestgifts

arepermitted Allocation of sharesinoversubscribed IPOstopersonalaccounts is

NOTpermitted Distinguish between gifts from clients and gifts fromentitiesseeking

influencetothe detrimentof the client Giftsmustbe disclosedtothe member’s

employerin anycase,either priorto acceptanceif possible,orsubsequently

Guidance—InvestmentBanking Relationships

Donotbe pressured by sell-side firmstoissuefavorable researchon currentor

prospective investment-banking clients Itisappropriatetohave analysts work with

investmentbankersin“road shows” only when the conflictsareadequately and

elfectively managed and disclosed.Be surethereareeffective “firewalls” between

research/investmentmanagementandinvestmentbankingactivities

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Guidance—Public CompaniesAnalysts shouldnotbe pressuredtoissuefavorable research by the companies theyfollow.Donotconfine researchtodiscussions with companymanagement,but ratheruseavariety ofsources,including suppliers,customers,and competitors

Guidance—Buy-Side ClientsBuy-side clientsmaytry topressuresell-side analysts Portfolio managersmayhave largepositionsinaparticularsecurity,andarating downgrademayhaveaneffectontheportfolio performance Asaportfolio manager, thereisaresponsibilityto respectandfoster intellectual honesty of sell-side research

Guidance—Fund Manager and Custodial RelationshipsMembers responsible for selecting outsidemanagersshouldnot acceptgifts,

entertainment,ortravel that might be perceivedasimpairing theirobjectivity

Guidance— PerformanceMeasurementandAttributionPerformance analystsmayexperiencepressurefrominvestment managerswho haveproducedpoorresultsoracted outside their mandate Members and candidates whoanalyzeperformancemust notlet such influences affect their analysis

Guidance—Manager SelectionMembers and candidatesmustexerciseindependence andobjectivitywhen they selectinvestment managers.They shouldnot acceptgiftsorother compensation that could

beseenasinfluencingtheirhiringdecisions, norshould they offer compensationwhen seekingtobe hiredasinvestmentmanagers Theresponsibilitytomaintainindependence andobjectivityappliestoallamemberorcandidate’shiringandfiring

decisions,notjust those that involveinvestmentmanagement.

Guidance—Credit Rating AgenciesMembers employed by credit rating firms should makesurethat proceduresprevent

undue influence by the firm issuing thesecurities.Members whousecredit ratingsshould beawareof this potential conflict ofinterestand consider whether independentanalysisiswarranted

Guidance—Issuer-Paid ResearchRemember that thistypeof researchisfraught with potential conflicts Analysts’

compensationfor preparing such research should belimited,and thepreferenceisfora

flatfee,without regardtoconclusionsorthereport’srecommendations

Guidance—TravelBestpracticeisfor analyststopayfor theirowncommercial travel whenattendinginformationeventsortourssponsored by the firm being analyzed

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

Recommended ProceduresforCompliance

• Protectthe integrity of opinions—makesuretheyareunbiased

• Createarestricted list and distribute only factual information about companieson

the list

• Restrictspecialcost arrangements—pay for one’sowncommercialtransportation

andhotel;limituseofcorporateaircraftto casesinwhich commercial transportation

isnotavailable

• Limitgifts—tokenitemsonly Customary, business-relatedentertainment isokay

aslongasits purpose isnot toinfluenceamember’s professional independenceor

objectivityFirmsshould impose clear value limitsongifts

• Restrictemployeeinvestments inequity IPOs andprivateplacements Require pre¬

approval ofIPOpurchases

• Reviewprocedures—haveeffective supervisory andreviewprocedures

• Firmsshould have formalwrittenpoliciesonindependence and objectivity of

research

• Firmsshould appointacompliance officer and provide clear procedures for

employee reporting of unethical behavior and violations of applicable regulations

ApplicationofStandard1(B)Independence and Objectivity

Example1:

StevenTaylor,amining analyst withBronson Brokers, isinvited byPrecisionMetalsto

joinagroup of hispeers ina tourof mining facilitiesinseveralwesternU.S.states.The

company arranges for chartered groupflights fromsitetositeandfor accommodations

inSpartanMotels,the only chain with accommodationsnearthemines,for threenights

Taylor allowsPrecisionMetalstopick up histab,asdo the other analysts, withone

exception— JohnAdams, anemployee ofalargetrustcompanywhoinsistsonfollowing

hiscompany’spolicy and paying for his hotelroomhimself

Comment:

The policy of thecompanywhere Adams works complies closely with Standard1(B) by

avoidingeventhe appearance ofaconflictofinterest,but Taylor and the other analysts

werenotnecessarily violating Standard1(B).Ingeneral, when allowing companiestopay

for travel and/or accommodations under thesecircumstances,members and candidates

must usetheir judgment, keepinginmindthat sucharrangements must notimpinge

onamemberorcandidate’s independence and objectivity In this example, the tripwas

strictly for business and Taylorwas notaccepting irrelevantorlavish hospitality The

itineraryrequired chartered flights, for which analystswerenotexpectedtopay.The

accommodationsweremodest Thesearrangements are notunusual and didnotviolate

Standard1(B) solongasTaylor’s independence and objectivitywerenotcompromised

In the final analysis, members and candidates should consider both whether theycan

remainobjective and whether their integrity might be perceived by their clientstohave

been compromised

Example2:

WalterFritz is anequityanalyst with HiltonBrokeragewhocoversthe mining industry

Hehas concluded that the stock of Metals&Miningisoverpricedatitscurrentlevel,

but heisconcerned thatanegative researchreportwill hurt thegoodrelationship

between Metals&Mining and theinvestment-banking division of his firm.In fact,a

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

madetoMetals&Miningtounderwriteadebt offering.Fritzneedstoproducea report

rightawayandisconcerned about issuingaless-than-favorable rating

Comment:

Fritz’s analysis of Metals&Miningmustbe objective and based solelyonconsideration

ofcompanyfundamentals Anypressurefrom other divisions of his firmisinappropriate

This conflict could have been eliminatedif, inanticipation of the offering, HiltonBrokerage had placed Metals&Miningon arestricted list foritssalesforce

Example3:

Tom Wayneistheinvestmentmanager of the Franklin City EmployeesPensionPlan

Herecently completedasuccessful search for firmstomanagethe foreign equityallocationof the plan’s diversified portfolio.Hefollowed the plan’s standard procedure

of seeking presentations fromanumberof qualified firms and recommended that hisboard select Penguin Advisors because ofitsexperience, well-definedinvestmentstrategy,

andperformancerecord,whichwascompiled and verifiedinaccordance with theCFAInstituteGlobalInvestmentPerformance Standards Following the plan selection

of Penguin,a reporterfrom the FranklinCityRecord calledtoask if therewasanyconnectionbetween theactionand thefact that Penguinwasoneof thesponsorsofan

“investment fact-finding triptoAsia” that Wayne made earlierintheyear.The tripwas

oneof several conducted by thePensionInvestment Academy, which hadarrangedtheitinerary of meetings witheconomic, government,andcorporateofficialsinmajorcities

inseveralAsian countries.ThePensionInvestmentAcademy obtainssupportfor thecost

of these trips fromanumberofinvestment managers,including PenguinAdvisors;theAcademy thenpaysthe travelexpensesof thevariouspensionplan managersonthe tripand provides all meals and accommodations The president of Penguin Advisorswasone

of the travelersonthe trip

Comment:

Although Waynecanprobablyput togoodusethe knowledge he gained from the trip

inselectingportfoliomanagersandinotherareasof managing the pension plan, hisrecommendationof Penguin Advisorsmaybe tainted by the possible conflict incurredwhen he participatedinatrippaid for partly by Penguin Advisors and when hewasinthe daily company of the president of Penguin Advisors To avoid violating Standard

1(B),Wayne’s basicexpensesfor travel and accommodations should have been paid

by his employerorthe pension plan;contactwith the president of Penguin Advisorsshould have been limitedtoinformationaloreducationaleventsonly; and the trip, theorganizer, and thesponsor should have been madea matterof public record.Evenif hisactions werenotinviolationof Standard1(B),Wayne should have beensensitivetothepublic perception of the trip when reportedinthe newspaper and theextent towhichthe subjective elements of his decision might have been affected by the familiarity thatthe dailycontactof suchatrip would encourage This advantage would probablynotbeshared by competing firms

Example 4:

Ananalystinthecorporatefinance department promisesaclient that her firm willprovide full researchcoverageof the issuingcompanyafter the offering

Comment:

Thisisnot aviolation,but shecannotpromise favorable research coverage Research

mustbe objective and independent

Research opinions and recommendationsmustbeobjectiveand arrivedatindependently.

Following the boss’sinstructionswould beaviolation if the analyst determinedabuy

ratingisinappropriate

Example6:

A moneymanagerreceivesagift of significant value fromaclientas areward for good

performanceoverthe prior period and informs her employer of the gift

Comment:

Noviolation here because the giftisfromaclient andis notbasedonperformance going

forward,but thegiftmustbe disclosedtoher employer If the giftwerecontingenton

future performance, themoneymanager would havetoobtain permission from her

employer Thereasonfor both the disclosure and permission requirementsisthat the

employermustensurethat themoneymanager doesnotgiveadvantagetothe client

givingoroffering additional compensation,tothe detriment of other clients

Example7:

Ananalystentersintoa contract towritearesearchreportonacompany,paid for

by that company, foraflat fee plusabonus basedonattractingnewinvestorstothe

security

Comment:

Thisisaviolation because the compensationstructuremakes total compensation depend

onthe conclusions of thereport (afavorablereportwillattractinvestorsandincrease

compensation) Accepting the job foraflat fee that doesnotdependonthereport’s

conclusionsoritsimpactonshare priceispermitted, withproperdisclosure of thefact

that thereportisfundedby the subject company

Example8:

Atrustmanagerat abank selects mutual funds for clientaccountsbasedonthe profits

from “service fees” paidtothe bank by the mutual fund sponsor

Comment:

Thisisaviolation because thetrustmanagerhas allowed thefeestoaffect his objectivity

Example 9:

Ananalystperformingsensitivityanalysis forasecurity doesnot useonlyscenarios

consistentwithrecenttrends and historicalnorms

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

hires the member’sfirm,the membercontinuestospend significantamountsonentertainmentfor theunionleader andhisfamily

accountand placingit inadifferent composite Knowing that theinvestmentmanager

isimportanttothe firm andaclose friend of the firm’sCEO,the member doesnot

disclose this changeinherperformancereport.

Comment:

The member violated Standard1(B)by failingtoexerciseindependence and objectivity

inheranalysis Alteringcompositestoconcealpoorperformance also violates StandardIII(D)PerformancePresentationandmayviolate Standard1(C)Misrepresentation

1(C) Misrepresentation.Members and Candidatesmust notknowingly makeanymisrepresentations relatingtoinvestmentanalysis,recommendations,actions,orotherprofessionalactivities

GuidanceTrustisafoundationintheinvestmentprofession.Donotmakeanymisrepresentations

orgive false impressions This includesoral, electronic,and social mediacommunications.Misrepresentations include guaranteeinginvestmentperformanceandplagiarism.Plagiarismencompassesusingsomeoneelse’s work (reports,forecasts,models, ideas, charts,graphs, and spreadsheetmodels)without giving them credit

Knowingly omitting information that could affectaninvestmentdecisionor

performance evaluationisconsidered misrepresentation

Models and analysis developed by othersat amember’s firmarethepropertyof the firmandcanbe used without attribution.Areportwrittenby another analyst employed bythe firmcannotbe releasedasanother analyst’s work

Recommended ProceduresforCompliance

Agoodwaytoavoid misrepresentationisfor firmstoprovide employees who deal withclientsor prospects awrittenlistof the firm’s availableservicesandadescription of thefirm’s qualifications Employeequalifications should be accurately presentedaswell

To avoid plagiarism,maintainrecordsof all materials usedto generate reports orotherfirm products and properlycite sources(quotes andsummaries)inwork products

Informationfrom recognized financial and statistical reportingservicesneednotbecited

Members should encourage their firmstoestablish procedures forverifying marketingclaimsof thirdpartieswhose information the firm providestoclients

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

ApplicationofStandardI(C)Misrepresentation

Example1:

AnthonyMcGuire is anissuer-paid analyst hired by publicly traded companiesto

electronicallypromotetheir stocks.McGuirecreates awebsite thatpromoteshis

researcheffortsas aseeminglyindependent analyst.McGuireposts aprofile anda strong

buy recommendation for eachcompanyonthewebsite,indicating that the stockis

expectedtoincrease invalue.Hedoesnotdisclose the contractual relationships with the

companies hecovers onhiswebsite, inthe researchreportsheissues, orinthestatements

he makes about the companiesinInternetchatrooms

Comment:

McGuirehas violated Standard1(C)because theInternet siteand e-mailsaremisleading

topotentialinvestors.Even if therecommendationsarevalid andsupported with

thoroughresearch,hisomissionsregarding thetruerelationship between himself and the

companieshecovers constituteamisrepresentation.McGuirehasalso violated Standard

VI(A)Disclosure of Conflicts bynotdisclosing theexistenceofan arrangementwith the

companiesthroughwhich hereceives compensation inexchange for hisservices

Example2:

Claude Browning,aquantitative analyst for DoubleAlpha,Inc., returnsingreat

excitementfromaseminar.In thatseminar,JackJorrely,awell-publicized quantitative

analystat anational brokeragefirm,discussedoneof hisnewmodelsingreatdetail,

and Browningisintriguedby thenewconcepts.Heproceedsto testthismodel,making

some minormechanical changes but retaining theconcept,until he producessome

verypositive results Browning quicklyannouncestohis supervisorsatDouble Alpha

that he has discoveredanewmodel and that clients and prospective clients alike should

be informed of this positive findingasongoingproof of Double Alpha’s continuing

innovationand abilitytoadd value

Comment:

Although Browning tested Jorrely’s modelonhisownandevenslightly modifiedit,he

muststill acknowledge the originalsourceof the idea Browningcancertainly take credit

for thefinal,practicalresults;hecanalsosupporthis conclusions with hisown test.The

creditfor theinnovativethinking,however,mustbe awardedtoJorrely

Example3:

Paul Ostrowskiruns a2-person investmentmanagementfirm Ostrowski’s firm

subscribesto aservicefromalargeinvestmentresearch firm that provides research

reportsthatcanbe repackaged by smaller firms for those firms’ clients Ostrowski’s firm

distributes thesereports toclientsasits ownwork

Comment:

Ostrowskicanrelyonthird-party research that hasareasonable and adequatebasis,

but hecannotimply that heisthe author of thereport.Otherwise,Ostrowskiwould

misrepresent theextentof his workinawaythat would mislead the firm’s clientsor

prospective clients

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Amember makesan errorinpreparing marketing materials andmisstatestheamountof

assetshisfirmhasunder management.

Comment:

The membermust attempt to stopdistributionof the erroneousmaterialas soon as

theerrorisknown Simply making theerrorunintentionallyisnot aviolation,butcontinuingtodistributematerial knowntocontainasignificantmisstatementof factwould be

Example 5:

Themarketing departmentstatesinsales literaturethatananalyst hasreceivedanMBAdegree, buthehasnot.Theanalyst and othermembersof thefirm have distributedthisdocumentforyears

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

Comment:

To theextentthat the candidate used information and interpretation from the financial

publication without citingit,the candidateis inviolationof the Standard The

candidate should either obtain thereportandreferenceitdirectlyor,if he relies solely

onthe financial publication, shouldcitebothsources

Misconduct Members and Candidatesmust notengage inanyprofessionalconduct involving dishonesty,fraud, ordeceitor commitanyactthat reflects

adverselyontheir professional reputation, integrity,or competence.

1(D)

Guidance

CFAInstitutediscourages unethical behaviorinallaspectsof members’ and candidates’

lives.Donotabuse CFA Institute’s Professional Conduct Program by seeking

enforcement of this Standardtosettle personal, political,orother disputes thatarenot

relatedtoprofessional ethics

Recommended ProceduresforCompliance

Firms areencouragedtoadopt these policies and procedures:

• Develop and adoptacodeof ethics and make clear that unethical behavior willnot

be tolerated

• Giveemployeesalist of potential violations andsanctions,includingdismissal

• Checkreferences of potential employees

ApplicationofStandard1(D)Misconduct

Example1:

SimonSasserman isa trustinvestmentofficerat abankinasmall affluenttown.He

enjoyslunchingeveryday with friendsatthecountryclub,where his clients have

observed him havingnumerousdrinks Backatworkafterlunch,he clearlyisintoxicated

while makinginvestmentdecisions.Hiscolleagues makeapoint of handlingany

business with Sassermaninthe morning because they distrust his judgment after lunch

Comment:

Sasserman’sexcessivedrinkingatlunch and subsequentintoxicationatworkconstitute

aviolationof Standard1(D)because this conduct has raised questions about his

professionalism andcompetence.Hisbehavior thusreflects poorlyon him,his employer,

and theinvestmentindustry

Example2:

CarmenGarciamanagesamutual fund dedicatedtosocially responsible investing Sheis

alsoanenvironmentalactivist.Asthe resultof her participationatnonviolentprotests,

Garciahasbeenarrestedon numerousoccasionsfor trespassingonthepropertyofa

large petrochemical plant thatisaccusedof damaging theenvironment

Study Session 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Comment:

Generally, Standard1(D) isnot meant to coverlegal transgressions resulting fromacts

of civil disobedienceinsupportof personal beliefs because such conduct doesnotreflectpoorlyonthe memberorcandidate’s professional reputation, integrity,or competence.

II Integrity ofCapitalMarkets

11(A) MaterialNonpublicInformation.Members and Candidates whopossessmaterial nonpublic information that could affect the value ofan investmentmust not act or causeothersto act onthe information

GuidanceInformationis“material” ifitsdisclosure would impact the price ofasecurityorifreasonableinvestorswouldwantthe information before makingan investmentdecision

Ambiguousinformation,asfarasitslikely effectonprice,maynotbe consideredmaterial Informationis“nonpublic” untilithas been made availabletothe marketplace

Ananalyst conference callisnotpublic disclosure Selectively disclosing information bycorporationscreatesthe potential for insider-trading violations The prohibition againstactingonmaterial nonpublic information extendstomutual funds containing thesubjectsecuritiesaswellasrelated swaps and optionscontracts.

Somemembers and candidatesmaybe involvedin transactionsduring which theyreceivematerial nonpublic information provided by firms (e.g.,investmentbanking

transactions).Members and candidatesmayusetheprovided nonpublic information foritsintendedpurpose,butmust not usethe informationforanyotherpurposeunlessitbecomes public information

StudySession 1

Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

Guidance—MosaicTheory

Thereisnoviolation whenaperceptive analyst reachesaninvestmentconclusion about

a corporateactionoreventthroughananalysis of public information together with

itemsof nonmaterial nonpublic information

Guidance—Social Media

When gathering information frominternet orsocial mediasources,members and

candidates needtobeawarethatnotall ofit isconsidered public information Members

andcandidates should confirm thatanymaterial informationtheyreceivefrom these

sources isalso availablefrom publicsources,suchascompany press releasesorregulatory

filings

Guidance—Industry Experts

Members and candidatesmayseek insight from individuals who have specialized

expertisein anindustry.However,theymaynot act or causeothersto act onany

material nonpublic information obtained from theseexpertsuntil that information has

been publicly disseminated

RecommendedProceduresforCompliance

Make reasonableeffortstoachieve public dissemination of the information Encourage

firmstoadopt proceduresto preventmisuseof material nonpublic information.Usea

“firewall” within thefirm,with elements including:

• Substantial controlof relevant interdepartmentalcommunications,througha

clearanceareasuchasthe complianceorlegaldepartment

• Reviewemployee trades—maintain “watch,” “restricted,”and“rumor” lists

• Monitorandrestrictproprietary trading whileafirmis inpossession of material

nonpublic information

Prohibitionof all proprietary trading whileafirmis in possessionof material nonpublic

informationmaybe inappropriate becauseitmaysendasignaltothe market.Inthese

cases,firms should take thecontraside of only unsolicitedcustomertrades

ApplicationofStandard11(A)Material NonpublicInformation

Example1:

SamuelPeter,ananalyst with Scotland andPierce, Inc.,isassisting his firm witha

secondaryofferingforBrightIdeas Lamp Company Peter participates,viatelephone

conferencecall, inameeting with Scotland andPierceinvestment-banking employees

andBrightIdeas’ CEO Peterisadvised that the company’s earnings projections for

thenextyearhave significantly dropped Throughout the telephone conferencecall,

several Scotland andPiercesalespeople and portfolio managers walkinandoutof

Peter’soffice,where the telephone callistaking place Asaresult,theyare awareof the

dropinprojectedearnings forBrightIdeas Before theconference callis concluded,

the salespeople trade the stock of the companyonbehalfof the firm’sclients,and other

firm personnel trade the stockinafirm proprietaryaccountandinemployee personal

Elizabeth LevensonisbasedinTaipei andcoversthe Taiwanese marketfor herfirm,whichisbasedinSingapore Sheisinvitedto meetthe finance directorofa

manufacturingcompany,alongwith the othertenlargestshareholdersof thecompany

During the meeting, the finance directorstatesthat the companyexpectsitsworkforce

tostrikenextFriday, which will cripple productivity and distribution Can Levensonuse

this informationas abasistochange her ratingonthe company from “buy”to“sell”?

Jagdish Tejaisabuy-side analyst covering the furniture industry Looking foran

attractivecompanytorecommendas abuy, he analyzed several furniture makers bystudying their financialreportsand visiting their operations.Healso talkedto some

designers and retailerstofindoutwhich furniture stylesaretrendy and popular

Althoughnoneof the companies that he analyzed turnedout tobeaclear buy, hediscovered thatoneofthem,SwanFurnitureCompany(SFC),might beintrouble

Swan’sextravagant newdesignswereintroducedatsubstantialcosts.Eventhoughthesedesignsinitially attractedattention,inthelongrun,the publicisbuyingmoreconservativefurniturefrom other makers Basedonthat andonP&Lanalysis, Tejabelieves that Swan’snext-quarterearnings will drop substantially He thenissuesasellrecommendationfor SFC Immediately after receiving thatrecommendation, investmentmanagersstartreducing the stockintheirportfolios

Example 4:

Amember’sdentist,whoisanactiveinvestor,tells the member that basedonhisresearch he believes thatAcme,Inc.,will be boughtoutinthenearfuture byalargerfirminthe industry The member investigates and purchases shares ofAcme

Comment:

Thereis noviolation here because the dentist hadnoinside information but hasreached the conclusiononhisown.The information hereisnotmaterial because there

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2- Standardsof Practice Handbook

isno reasonto suspectthatan investorwould wishtoknow what the members dentist

thought before investinginsharesof Acme

Example5:

Amember receivedanadvance copy ofastock recommendation that will appearina

widely read nationalnewspapercolumn thenextday and purchases the stock

Comment:

Arecommendationinawidely read newspaper column will likelycausethe stock

priceto rise, sothisismaterial nonpublic information The member has violated the

Standard

Example 6:

A member trades basedoninformation hegetsby seeinganadvance copy ofanarticle

thatwill be publishedinaninfluential magazinenextweek

Comment:

Thisisaviolationasthisisnonpublic information until the article has been published

11(B) MarketManipulation Members and Candidatesmust notengagein practices

that distort pricesorartificially inflate trading volume with theintenttomislead

market participants

Guidance

This Standard appliestotransactionsthat deceive the market by distorting the price¬

setting mechanism of financialinstrumentsorby securingacontrolling positionto

manipulate the price ofarelated derivative and/ortheassetitself Spreading falserumors

isalso prohibited

ApplicationofStandard11(B)Market Manipulation

Example1:

Matthew Murphyis ananalystatDivisaderoSecurities & Co.,which hasasignificant

numberof hedge fundsamong itsmostimportant brokerage clients Two trading days

before the publication of the quarter-endreport,Murphy alerts his sales force that he

isabouttoissuearesearchreportonWirewolfSemiconductor,which will include his

opinion that:

• Quarterlyrevenuesarelikelytofall short of management’s guidance

• Earnings will beasmuchas5centspershare(ormorethan10%)belowconsensus

• Wirewolf’shighlyrespected chief financial officermaybe abouttojoin another

company

Knowing that Wirewolf hadalready entereditsdeclared quarter-end “quiet period”

before reporting earnings(andthus would bereluctanttorespondto rumors,etc.),

Murphytimesthe releaseof his researchreportspecificallytosensationalize the negative

aspectsof the messageto createsignificant downward pressureonWirewolf’sstockto

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

basedonspeculation,notonfact Thenextday, the researchreportisbroadcasttoall ofDivisadero’s clients andto the usualnewswire services

Before Wirewolfsinvestorrelations departmentcan assessitsdamageonthe finaltrading day of thequarterandrefute Murphysreport,itsstockopenstrading sharplylower,allowing Divisadero’s clientstocovertheir short positionsatsubstantial gains

Comment:

Murphy violated Standard11(B)by tryingto createartificial price volatility designedto

have material impactonthe price ofanissuer’sstock.Moreover,bylackinganadequatebasisfor therecommendation,Murphy also violated StandardV(A)

Example2:

ACMEFuturesExchangeislaunchinga newbondfuturescontract.Toconvince

investors,traders,arbitragers, hedgers, andso on, to useitscontract,the exchange

attempts todemonstrate thatithas the best liquidity To doso,itentersintoagreements

with memberssothat theycommitto asubstantialminimumtrading volumeonthenewcontract over aspecific periodinexchange for substantial reductionsontheirregularcommissions

Comment:

The formal liquidity ofamarketisdetermined by the obligationsset onmarketmakers,but the actualliquidity ofamarketisbetter estimated by the actual trading volumeand bid-ask spreads Attemptstomislead participantsonthe actual liquidity of themarketconstituteaviolationof Standard11(B).Inthis example,investorshave beenintentionally misledtobelieve they chose themostliquidinstrumentforsomespecificpurposeand could eventuallyseethe actual liquidity of thecontractdryupsuddenlyafter thetermof theagreementif the “pump-priming”strategyfails.If ACME fullydisclosesitsagreementwith memberstoboosttransactionsover someinitial launchperiod,itdoesnotviolate Standard11(B).ACME’sintent isnot toharminvestorsbutonthecontrary togive themabetterservice.For thatpurpose, it mayengageinaliquidity¬

pumpingstrategy,butitmustbe disclosed

Example 3:

Amemberisseekingtosellalargepositioninafairly illiquid stock fromafund hemanages.Hebuys and sells shares of the stock between that fund and another he alsomanagesto create anappearanceof activity and stock price appreciation,sothat the sale

of the whole position will have less market impact and he will realizeabetterreturnforthe fund’s shareholders

Comment:

The tradingactivity ismeant tomislead market participants andis,therefore,aviolation

of the Standard The fact that his fund shareholders gain by thisactiondoesnotchangethefact thatit isaviolation

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Example 4:

Amemberpostsfalse information aboutafirmoninternetbulletin boards and stock

chat facilities in anattempt to causethe firm’s stocktoincrease in price

Comment:

Thisisaviolationof the Standard

DutiestoClientsIII

III(A) Loyalty,Prudence,andCare.Members and Candidates haveaduty of loyalty

totheir clients andmust actwithreasonablecareandexerciseprudent judgment

Members and Candidatesmust actfor the benefit of their clients andplacetheir

clients’interestsbefore theiremployer’sortheirown interests.

Guidance

Clientinterestsalwayscomefirst Although this Standard doesnotimposeafiduciary

dutyonmembersorcandidateswhereonedidnotalreadyexist, itdoes require members

and candidatesto actintheir clients’ bestinterestand recommend products thatare

suitable giventheir clients’investmentobjectives andrisk tolerances

• Exercisethe prudence,care,skill,and diligence under thecircumstancesthata

personactinginalike capacity and familiar with suchmatterswould use.

• Managepoolsof clientassetsin accordance with thetermsof the governing

documents,suchas trustdocumentsorinvestmentmanagement agreements.

• Makeinvestmentdecisionsinthecontextof the total portfolio

• Inform clients ofanylimitationsinanadvisory relationship (e.g.,anadvisor who

mayonlyrecommend herownfirm’sproducts)

• Vote proxies inaninformed and responsiblemanner.Dueto costbenefit

considerations, it maynotbe necessaryto voteall proxies

• Client brokerage,or“soft dollars”or“softcommissions”mustbe usedtobenefit the

client

• The “client” may be the investingpublicas awhole rather thanaspecificentityor

person

Recommended ProceduresofCompliance

Submittoclients,atleast quarterly, itemizedstatementsshowingall securities incustody

andalldebits,credits,andtransactions

Encourage firmstoaddress these topics when drafting policies and procedures regarding

fiduciary duty:

• Follow applicable rules and laws

• Establishinvestmentobjectives ofclient.Consider suitability of portfolio relativeto

client’s needs andcircumstances,theinvestment’s basic characteristics,orthebasic

characteristicsof the totalportfolio

• Diversify

• Deal fairly with all clientsinregardstoinvestment actions

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

• Voteproxiesinthe bestinterestof clients and ultimate beneficiaries

• Maintainconfidentiality

• Seek bestexecution

• Place clientinterestsfirst

ApplicationofStandard111(A)Loyalty,Prudence,and CareExample1:

FirstCountry Bankserves as trusteefor the MillerCompany’spensionplan Miller

isthetargetofahostile takeoverattemptbyNewton,Inc Inattemptingtowardoff

Newton,Miller’smanagerspersuadeJulianWiley,aninvestment manageratFirstCountryBank,topurchase Millercommonstockinthe open market for the employeepensionplan Miller’s officials indicate that suchactionwould be favorably received andwould probably resultinotheraccountsbeing placed with the bank.AlthoughWileybelieves the stocktobe overvalued and wouldnotordinarily buyit,he purchases thestockto supportMiller’s managers,tomaintainthecompany’s goodfavor,andtorealizeadditionalnewbusiness The heavy stock purchasescauseMiller’s market pricetoriseto

suchalevel that Newtonretractsitstakeover bid

Comment:

Standard111(A)requires thatamemberorcandidate, inevaluatingatakeoverbid,act

prudently and solelyintheinterestsof plan participants and beneficiaries Tomeetthisrequirement,amemberorcandidatemustcarefully evaluate the long-termprospectsofthecompanyagainst the short-termprospectspresented by the takeover offer and bythe abilitytoinvestelsewhere.Inthisinstance,Wiley, actingonbehalfof his employer,thetrustee,clearly violated Standard111(A)by using the pensionplanto perpetuate

existingmanagement,perhapstothe detrimentof plan participants and thecompany’s

shareholders,andtobenefit himself Wiley’s responsibilitiestothe plan participantsand beneficiaries should take precedenceoverany tiesto corporatemanagers and self-interest Adutyexiststoexaminesuchatakeover offeronits own meritsandtomake

anindependent decision The guiding principleisthe appropriateness of theinvestmentdecisiontothe pension plan,notwhether the decision benefits Wileyorthecompanythat hired him

Example2:

EmilieRome isa trustofficerfor PagetTrustCompany Rome’s supervisorisresponsiblefor reviewing Rome’strust accounttransactionsand her monthlyreportsof personalstocktransactions.Romehas been using Nathan Gray,abroker,almost exclusively for

trust accountbrokeragetransactions.Where Gray makesamarketin stocks,he has beengivingRomealower price for personal purchases andahigher price for sales than hegivestoRome’strust accountsand otherinvestors

Comment:

Rome isviolating her duty of loyaltytothe bank’strust accountsby using Gray forbrokeragetransactionssimply because Gray trades Rome’s personalaccountonfavorable

terms.

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Example3:

Amemberuses abrokerfor client-account trades that has relatively high prices and

averageresearch andexecution Inreturn,thebroker pays fortherentandother

overheadexpensesfor the member’s firm

Comment:

Thisis aviolationof theStandardbecausethe memberusedclientbrokerageforservices

that do notbenefit clients and failedto getthe best price andexecutionfor his clients

Example 4:

Inreturnforreceivingaccount managementbusinessfrom BrokerX, amember directs

tradestoBroker Xontheaccountsreferredtoher by BrokerX, aswellas onother

accounts as anincentivetoBroker Xtosend hermore accountbusiness

Comment:

Thisis aviolation ifBroker Xdoesnotofferthebest priceandexecutionorifthe

practice of directing tradestoBrokerX isnotdisclosedtoclients Theobligationtoseek

best priceandexecutionisalways required unless clients provideawrittenstatementthat

the memberisnot toseek best price andexecutionand that theyare awareoftheimpact

of thisdecisionontheiraccounts.

Example 5:

Amember doesmoretradesinclientaccountsthanarenecessarytoaccomplish client

goals becauseshedesiresto increasehercommission income.

Comment:

The memberisusing clientassets(brokeragefees)tobenefit herself and has violatedthe

Standard

III(B) FairDealing Members and Candidatesmustdeal fairly and objectivelywith

all clients whenprovidinginvestmentanalysis, makinginvestment recommendations,

takinginvestment action, orengaging in otherprofessionalactivities.

Guidance

Donotdiscriminate againstany clientswhen disseminating recommendationsortaking

investment action.Fairly doesnot meanequally In thenormalcourseofbusiness,

there willbedifferencesinthetimee-mails,faxes,etc., arereceived by different clients

Differentservicelevelsareokay, but theymust notnegatively affectordisadvantage

anyclients.Disclose thedifferentservicelevelstoall clients andprospects,andmake

premium levels ofserviceavailabletoall who wishtopayfor them

Guidance—InvestmentRecommendations

Giveall clientsafair opportunityto actupon everyrecommendation.Clientswho

are unawareofachangeinarecommendation should be advised before the orderis

accepted

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

Guidance—Investment ActionsTreat clients fairlyinlight of theirinvestmentobjectives andcircumstances.Treatbothindividual and institutional clientsinafairand impartialmanner.Membersandcandidates shouldnottakeadvantage oftheirpositionin theindustrytodisadvantageclients (e.g.,inthecontextofIPOs).

E Recommended ProceduresforCompliance

Encourage firmstoestablish compliance procedures requiringproperdisseminationofinvestmentrecommendations andfairtreatmentof allcustomersandclients.Considerthese points when establishing fair dealing compliance procedures:

• Limitthenumberofpeoplewhoare awarethatachangein recommendationwill bemade

• Shorten thetimeframe between decision and dissemination

• Publish personnel guidelinesforpre-dissemination—haveinplace guidelinesprohibiting personnelwho have priorknowledgeofarecommendationfromdiscussingitortakingaction onthe pending recommendation

• Simultaneous disseminationofnew orchanged recommendationstoall clients whohave expressedaninterestorfor whomaninvestment issuitable

• Maintainlistof clients andholdings—use toensure that allholdersaretreated fairly

• Developwrittentrade allocation procedures—ensure fairnesstoclients,timely andefficient orderexecution,andaccuracy ofclientpositions

• Disclose trade allocation procedures

• Establish systematicaccount review—ensurethatnoclientisgivenpreferred

treatmentandthatinvestment actions are consistentwith theaccount’s objectives

• Disclose available levelsof service

ApplicationofStandardIII(B) FairDealingExample1:

BradleyAmes, awell-known and respected analyst, follows thecomputerindustry Inthe courseofhis research, hefinds thatasmall,relatively unknowncompanywhosesharesaretraded overthecounterhas justsignedsignificantcontractswithsomeof thecompanies hefollows.Afteraconsiderableamountofinvestigation,Amesdecidesto

writearesearchreport onthe company and recommendpurchase.While thereport is

being reviewed bythe company forfactualaccuracy, Amesschedulesaluncheon withseveralofhisbestclientstodiscussthecompany At the luncheon, he mentions thepurchase recommendation scheduledtobesentearly the followingweektoall the firm’sclients

Comment:

Amesviolated StandardIII(B)by disseminatingthepurchase recommendationtotheclients with whom he had lunchaweek before the recommendationwas sent toallclients

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Cross-Reference to CFA InstituteAssigned Readings#1 & 2-Standards of Practice Handbook

fewyears later, Riverscomparesthe results of his pension fund with those of the bank’s

commingled fund.Heisstartledtolearn that,eventhoughthetwo accountshave the

sameinvestmentobjectives and similarportfolios, his company’s pension fund has

significantlyunderperformedthe bank’scommingled fund Questioningthisresultat

hisnextmeeting with thepension fund’smanager, Rivers istoldthat,as a matterof

policy,whena newsecurityisplacedontherecommendedlist,MorganJackson,the

pensionfundmanager,firstpurchases thesecurity forthe commingledaccountandthen

purchasesiton aproratabasisforallother pensionfundaccounts.Similarly,whena

saleis recommended,thesecurity issold first from the commingledaccountand then

soldon aproratabasisfromallotheraccounts.Riversalsolearnsthatifthebankcannot

getenough shares (especially the hotissues)tobe meaningfultoall theaccounts,its

policyis toplacethenew issuesonlyin thecommingledaccount.

Seeingthat Riversisneither satisfiednorpleased bytheexplanation,Jacksonquickly

addsthatnondiscretionarypensionaccountsand personaltrust accountshavealower

priorityonpurchase andsalerecommendationsthandiscretionarypensionfund

accounts.Furthermore,Jacksonstates,the company’spensionfund had the opportunity

toinvest upto5% in thecommingled fund

Comment:

The bank’spolicy didnot treatallcustomersfairly, andJacksonviolatedherdutyto

her clientsby giving prioritytothe growth-oriented commingled fundoverall other

funds andtodiscretionaryaccountsovernondiscretionaryaccounts.Jacksonmust

executeorderson asystematicbasisthatisfairtoall clients.In addition,trade allocation

procedures shouldbedisclosedtoall clients from thebeginning.Ofcourse,in thiscase,

disclosureof the bank’s policy wouldnotchange the fact that the policyisunfair

Example 3:

A membergetsoptions for hispartinanIPOfrom thesubjectfirm The IPOis

oversubscribed and the member fills hisownand other individuals’ orders but hasto

reduceallocationstohisinstitutionalclients

Comment:

The memberhas violatedtheStandard.Hemustdisclosetohisemployer andtohis

clientsthathe has accepted options for putting together theIPO.Heshouldnottake

any shares ofahotIPOfor himselfand should have distributedhisallocatedsharesof

theIPOtoall clientsinproportiontotheir original orderamounts.

Example 4:

A memberisdelayedinallocatingsometradestoclientaccounts.When she allocates the

trades,sheputs somepositions that haveappreciatedinapreferred client’saccountand

putstradesthat havenotdoneaswellin other clientaccounts.

Comment:

Thisisaviolationof the Standard The member should have allocated the tradesto

specificaccountspriorto thetradesorshouldhaveallocatedthetrades proportionallyto

suitableaccountsinatimely fashion

.2

CD

Sinceshe hasa reason (minimumlotsize) todeviatefroma strictprorataallocationto

herclients,thereisnoviolationofFairDealing

Makeareasonable inquiryinto aclient’sorprospective clients’

investment experience, riskandreturnobjectives, andfinancialconstraintspriortomakingany investmentrecommendationortakinginvestment actionandmust reassessandupdatethisinformationregularly

a.

Determinethataninvestmentissuitabletotheclient’sfinancialsituation

andconsistentwith the client’swrittenobjectives,mandates,andconstraints beforemakingan investmentrecommendationortakinginvestment action

b

Judge the suitability ofinvestments in thecontextof the client’s totalportfolio

c.

2 WhenMembersandCandidatesareresponsible for managingaportfolio

to aspecificmandate,strategy,orstyle, theymustmakeonlyinvestmentrecommendationsortakeinvestment actionsthatare consistentwith the statedobjectives andconstraintsof theportfolio

Guidance

Inadvisory relationships,be suretogatherclient informationatthebeginningof therelationship,in theform ofaninvestmentpolicystatement(IPS).Consider clients’

needs andcircumstances andthus their risk tolerance.Considerwhetheror nottheuse

of leverageissuitablefor the client

Ifamember isresponsible for managingafundto anindexorotherstatedmandate, be

sureinvestmentsareconsistentwith the stated mandate

Guidance—Unsolicited TradeRequests

Aninvestmentmanagermightreceive aclientrequest topurchaseasecurity that themanagerknowsis unsuitable,giventheclient’sinvestmentpolicystatement.Thetrademayormaynothaveamaterialeffectonthe risk characteristicsof the client’s total