CFA 2018 level 3 gostudy ethics 2016

Reproduced and republished from 2016 Learning Outcome Statements, Level III CFA® Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute’s Global Investment

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2016 Guided Notes

Ethics

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Guided Notes for CFA® Level 3 – 2016

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Reproduced and republished from 2016 Learning Outcome Statements, Level III CFA® Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute’s Global

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Ethics (Study Session 1, Reading 1 & 2)

Ethics will show up in an afternoon selected response item set It will count for about 10-15%

Having gone through Level 1 and Level 2, you already know that Ethics is a unique section in that there is comparatively little to memorize For example, the CFA exam is not going to ask you to know what Standard I(a) is versus Standard II(b) by those names There will, however, be questions that ask you to choose which standard (or standards) is violated based on a passage and then list the different standards as the multiple choice options

Past Level III exams have seen more questions on compliance, portfolio management, and the asset manager code of conduct than L1 and L2 Questions around suitability and fiduciary duty have been especially prominent, perhaps reflecting the core focus of L3

The bottom line: Basic knowledge is assumed, and it is probably worth at least one read through

the Institute’s official ethics guide within a month or so of the exam, but for the most part you are better off doing lots of practice problems to get a feel for how to answer these questions That’s why we keep our overview of Ethics very high level and in outline form

Basic Principles for Answering Ethics Questions

Knowing which questions to ask when faced with an Ethics question can help you sort through the different options to arrive at the right answers Here are three key questions and two

guidelines to help you:

Questions

1 All CFA Institute members and candidates are required to comply with the Code and Standards So …does the action uphold the profession?

2 If you were the client would you agree with the course of action?

3 Would a moral person, or leader, follow this course of action?

Principles

1 When in doubt err towards the more strict guideline/regulation

2 There are differences between requirements as laid out in the Standards and

recommended practice or guidance This distinction is often tested

Ethics boils down to the golden rule How would you want your financial advisor to act? What actions should they take with respect to you and your portfolio?

Chances are you’d want them to act in your interests and not those of someone else paying them You would want them to communicate what they’re doing and explain why, to be honest in reporting results, and to do it frequently enough that you don’t worry about what’s going on Finally, an investment professional should also uphold the integrity of capital markets, (which you can think of as the greater good), even at their own expense.1

Always remember, there is a simple order of priority that should guide your actions—capital markets, clients, employer, then you

1 Think Spiderman, with great power (you CFA Charterholder) comes great responsibility

One Page Ethics Tear Sheet

Summarizing the Code of Ethics -PEJMAR 2

Priority - Your client's interests always come first (then your employer, then you)

Encourage - Practice and encourage others to act professionally and ethically to reflect credit on yourself and the

profession

Judgment - Use reasonable care and judgment when performing all professional activities

Maintain - Keep your knowledge up to date and encourage other professionals to do the same

Actions - Employ integrity, competence, diligence, and respect in an ethical manner with everyone

Rules - Promote the integrity of capital markets by following the rules

Standards of Professional Conduct

1 Professionalism

a Knowledge of the Law: Have to know them, comply with stricter of CFA, local, home law

b Independence and Objectivity: Reasonable care, compensation ??s/issuer paid research

c Misrepresentation: Knowingly misrepresenting/omitting information, commit plagiarism

d Misconduct: Fraud, Negative light on profession Distinction btwn personal/professional

2 Integrity of Capital Markets

a Material nonpublic information: Can’t trade on it or cause others too MOSIAC theory

b Market Manipulation: Artificially distort price or volume with intent to deceive

3 Duties to Clients

a Loyalty, prudence, and care: Act for benefit of client above employer/you Fiduciary duty

b Fair Dealing: Fair and objective Disclose different levels of service (OK w/ no negative)

c Suitability: In context of Risk constraints from IPS Evaluate on portfolio level vs risk of just 1

security (prudent investor rule)

d Performance and Presentation: Fair, accurate, fact vs opinion Recommend keep records for 7

years

e Preservation of Confidentiality: Always for past/present clients unless illegal, required, or for

CFA institute investigation

4 Duties to Employers

a Loyalty: Employer before you Questions around quitting and taking client info/models often get

tested

b Additional Compensation Arrangements: Disclose first Written consent from all parties is

required

c Responsibilities of Supervisors: Reasonable effort to detect/disclose violations 2015 has moved to

slightly more proactive duty to educate

5 Investment Analysis, Recommendations, and Actions

a Diligence and Reasonable Basis: Cover basis for investment, thorough, disagreeing on a group

recommendation is OK

b Communications with clients/ prospective clients: Would you want to know something if you were

the client? If yes, then disclose it

c Record retention: Electronic OR paper OK Recommendation: Keep records for 7 years

6 Conflicts of Interest

a Disclosure of Conflicts: Disclose anything that would interfere with independence and objectivity

b Priority of Transactions: Clients > Employers > You Treat paying family the same as other

clients

c Referral Fees: Full disclosure so clients can judge potential biases Often in SD 3 context

7 Responsibilities as a CFA Institute Member/Candidate

a Conduct: Don’t cast negative light on profession or capital markets via your actions

2 From http://www.investopedia.com/exam-guide/cfa-level-1/ethics-standards/code-ethics.asp and

http://quizlet.com/3424974/cfa-ethics-code-and-standards-flash-cards/

3 Soft Dollar

The Code of Ethics4

1 Investment professionals should act with integrity, competence, diligence, and respect They should convey their actions in an ethical manner to their clients, potential clients, and

employers

2 Investment professionals should place personal interests below the interest of clients and the integrity of the investment profession

3 Investment professionals should act with care and maintain independent judgment when applying investment analysis, recommendations, and actions Analysts must use independent judgment when engaging in activities that will ultimately affect client interests

4 Analysts should not only act in an ethical manner, but should promote ethical actions of others within the profession

5 Investment professionals should contribute to well-functioning markets by respecting the applicable rules and promoting those rules to others

6 Investment professionals should strive to maintain and improve their professional

competence, as well as the competence of others within the investment profession

Standard I: Professionalism

1 Knowledge of the Law

Keys: Know the rules Comply with the more strict law, regulation, or CFA standard

Disassociate from any violations

a You have to know, stay up-to-date and comply with the law No excuses

2 Independence and Objectivity

Keys: Reasonable Care and judgment, don’t accept compensation that can impact objectivity

a Maintain independence and objectivity in all professional activities

i No Gifts that can compromise even appearance of objectivity Modest gifts OK Gifts from clients are more OK than those seeking influence

ii No invites to lavish entertainment/functions/tickets (often tests the

distinction between lavish and reasonable accommodation to go do research on a company)

iii No favors/job referrals/or participation in oversubscribed IPOs

iv Potential pressure from sell-side to have buy side issue favorable reports

(Guidance: establish effective firewalls, restricted securities, limit gifts to

nominal amounts) Note on Issuer Paid Research: Research must be thorough, unbiased, and independent The

analyst must FULLY DISCLOSE conflicts and compensation structure A flat fee that is

independent of the report’s conclusions is recommended but not required

3 Misrepresentation

a Must not knowingly give false impression in written, oral, advertising, or

electronic communication This includes omitting facts

b Must not misrepresent:

i Credentials

ii Services offered

4 From CFA Institute Official Code of Ethics…

iii Performance record

iv Investment characteristics (or guarantee a return)

v Plagiarism

1 Cannot plagiarize Can use common sources like US treasury without attribution however (and this is commonly tested)

4 Misconduct

a Don’t do it! Nothing dishonest, fraudulent, or with an adverse impact on

profession or professional reputation Note the CFAI is very concerned with the

reputation of capital markets and its own self Anything that makes them look bad

in a professional setting is probably a violation

Standard II: Integrity of Capital Markets

1 Material Nonpublic Information

a If you have material nonpublic information (info that could affect an investment’s value) you CANNOT act or CAUSE ANOTHER to act on that information

i Material: Material if disclosure would impact security price or is

something a reasonable investor would want to know about the company

ii Nonpublic until made available to entire marketplace (NOT just analysts)

iii MOSIAC THEORY

1 Mosaic theory involves collecting public and public

non-material information about a company in order to piece together a

conclusion about its price If disparate sources of acceptable information lead to putting together the puzzle that’s ok That’s what analysts get paid to do after all

2 Market Manipulation

a Do not artificially distort price or volume with an intent to mislead market

participants including through releasing false information Variations of this are

frequently tested

Standard III: Duties to Clients

1 Loyalty, Prudence, and Care

1 Act with reasonable care and exercise prudent judgment

2 Act for benefit of client, place employer interests ahead of your own

3 Must comply with all fiduciary duties

2 Fair Dealing

1 Be fair and objective around analysis, recommendations, and professional activity

i Service Levels: Different levels of service are OK but only if disclosed and does not disadvantage any clients EX: I can offer more research to a set

of clients that pay more, but I can’t release trade recommendations to them earlier

ii Allow clients a fair chance to act on recommendations and notify them of changes to recommendations before executing a client trade

!! If conflict

exists between

written IPS and

client wishes,

follow IPS

!! Often test

professional versus

personal

misconduct

3 Suitability

1 Know client’s Risk and Return (think IPS constraints) and take action consistent with those constraints Suitability is from a PORTFOLIO perspective not that of

an individual security Invest to the fund mandate if managing a fund

4 Performance Presentation

1 Fair, accurate, and complete (will most likely be tested with GIPS not in Ethics)

i Do not guarantee performance or misstate past performance

5 Preservation of Confidentiality

1 Keep Client (and former client) info confidential unless:

i Illegal activities are suspected

ii Disclosure is required by law iii Client or prospect allows disclosure

2 Providing information to CFA Institute for investigation is not a violation of this standard

Standard IV: Duties to Employers

1 Loyalty

1 Act for the benefit of the employer

i If also practicing independently then written permission from employer is required

ii When leaving employer

1 Act in their best interest until gone

2 Do not take records without permission (just knowing names and contacting once gone is OK)

iii Whistle blowing: OK if it protects client or capital markets not OK for personal gain

2 Additional compensation

i No gifts/compensation that interfere with duty to employer or creates

conflict of interest UNLESS written permission obtained from ALL

parties (email is acceptable)

3 Responsibilities of Supervisors

1 Must make reasonable efforts to detect and prevent violations

Standard V: Investment Analysis, Recommendations, and Actions

1 Diligence and Reasonable Basis

a Reasonable and adequate basis supported by research for analysis or

recommendation

i Cover all relevant issues and document when making investment recommendation

ii Determine soundness of third-party research iii In groups, OK to disagree and not disassociate as long as basis is sound

2 Communication with Clients and Prospective Clients

Guidanc

e 

Key: Would you want to know the information is the situation was reversed? If yes, then

disclose

a Disclose format and principals of investment processes & any changes to process

b Include important factors for recommendations in communication (like basic characteristics of the security)

c Distinguish clearly between fact and opinion

3 Record Retention

a Develop & maintain appropriate records with support for decisions (guidance is to keep 7 years in either electronic or paper form) Records are firm property

Standard VI: Conflicts of Interest

1 Disclosure of Conflicts

a Must make full, fair disclosure to clients, prospects, and/or employer on any matter that could reasonably be expected to interfere with independence or objectivity Disclosure is important to:

i Allow clients to judge motives (e.g relationship with broker, stock ownership)

ii So employers can judge any financial pressures that could influence your

decision as an advisor (non-financial compensation is often referenced, it

counts too)

2 Priority of Transactions

a Clients first, then employers, then and only then your transactions (no

front-running)

i Family member accounts with firm MUST be treated like any other

account Giving worse treatment to family is a violation They are a client

too

3 Referral Fees

a Disclose all fees so clients can evaluate full cost and potential biases

Standard VII: Responsibilities of a CFA Institute Member or CFA Candidate

1 Must not engage in any conduct that compromises reputation or integrity of CFA Institute

or the CFA designation or exams

a Cheating on exam, disregarding policies, giving confidential info away, improper use of CFA designation, misrepresenting the CFA program are all examples of such conduct

2 Referring to the CFA Institute, Designation, or Program

a Must not misrepresent or exaggerate the meaning or implications of membership

i May reference participation but not a “partial designation”

ii May say passed all 3 on first attempt, but NOT indicate superior performance or ability because of this

iii Chartered Financial Analyst and CFA marks always come after a charter holder’s name or are used as adjectives not nouns

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