Back to blog

READING 3 - Guidance for Standards I-VII

EXAM FOCUS

The standards of Professional Conduct comprise seven Standards (I-VII) and a total of 22 subsections. These Standards and their application are described in the Standards of Practices Handbook, 11th Edition, 2014, published by CFA Institute. We recommend carefully reading the Standards of Practice Handbook multiple times in preparation for your Level I exam (yes, the whole thing, including all examples). Fifteen percent of your exam questions will be based on this book and the two relatively short readings concerning Global Investment Performance Standards(GIPS). Give that much of this material must simply by memorized, we also suggest that your final reading of the Standards of Practice Handbook be on the Friday prior to your exam. You probably don't need to read all the examples that day, but if you highlighted some points during an earlier reading, you can revisit those as you go through all the Standards, the guidance, and the recommended best practices.

MODULE 3.1: GUIDANCE FOR STANDARDS I(A) AND I(B)

LOS 3.a: Demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues fo professional integrity.

LOS 3.b: Distinguish between conduct that conforms to the Code and Standards and conduct that violates the Code and Standards.

LOS 3.c: Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.

CFA Program Curriculum, Volume 1, page 55

The Standards of Practice Handbook is include ini its entirety in the CFA curriculum as Readings 2 and 3 of Volume 1. You can also download a PDF of Standards of Practice Handbook at the website for CFA Institute, www.cfainstitute.org. A third alternative is to purchase the Standards of Practice Handbook through Amazon (make sure you get the 11th edition) for about $30 or get the kindle edition for $‚Äč0.99.

In out summary of the Standards of Practice, we focus on describing three things: (1) actions that clearly violate the subsection, (2) the behaviors that each subsection is intended to either encourage or discourage, and (3) recommended best practices for members and their firms.

In many cases the actions that members and candidates must not take are explained using terms open to interpretation, such as "reasonable","adequate", and "token".

Some examples from the Standards themselves are: ...use reasonable care and judgement to achieve... ...accept any gift, that reasonable could be expected to compromise... ...act with reasonable care and exercise prudent judgement... ...deal fairly and objectively with all clients... ...make a reasonable inquiry into... ...make reasonable effort to ensure... ...might reasonably be expected to create a conflict of interest with... ...Have a reasonable and adequate basis... ...Use reasonable judgement in... ...matters that could be reasonably expected to impair...

The requirement of the LOS is that you know what constitutes a violation, not that you draw a distinction between what is "reasonable" and what is not in a given situation. we believe the exam writers take this into account and that if they intend, for example, to test whether a recommendation has been given without reasonable care and judgement, it will likely be clear either that the care and judgement exhibited by the analyst did not rise to the level of "reasonable", or that it did.

No monetary value for a "token" gift is given in the Standards, although it is recommended that a firm establish such a monetary value for its employees. Here, again, the correct answer to a question will not likely hinge on candidates's determination of what is a token gift and what is not. Questions should be clear in this regard. A business dinner is likely a token gift, but a week at a condominium in Aspen or tickets to the Super Bowl are likely not. Always look for clues in the questions that lead you to the question-writer's preferred answer choice, such as "lavish" entertainment and "luxury" accommodations.

Next, we present a summary of each subsection of the Standards of Professional Conduct. For each one, we first detail actions that violate the Standard and the list actions and behaviors that recommended within the Standards. We suggest you learn the violations especially well so you understand that the other items are recommended. For the exam, it is not necessary to memorize the Standard number and subsection letter. Knowing that an action violate, for example, Professionalism, rather than Duties to Employers or Duties to Clients, should be sufficient in this regard. Note that some actions may violate more than one Standard.

One way to write questions for this material is to offer a reason that might make one believe a Standard does not apply in a particular situation. In most, if you are prohibited for some action, the motivations for the action or other circumstances simply do not matter. If the Standard says it's a violation, it's a violation. An exception is when intent is key to the Standard, such as intending to mislead clients or market participants in general.

STANDARD I: PROFESSIONALISM

Standard I(A) Knowledge of the Law

Members and Candidates must understand and comply with all applicable laws, rules, and regulations (including CFA Institute Code of Ethics and Standards of Professional Conduct) of any government, regulatory organization, licensing agency, or professional association governing their professional activities. In the event of conflict, Members and Candidates must comply with the more strict law, rule, or regulation. Members and Candidates must not knowingly participate or assist in and must dissociate form any violation of such laws, rules, or regulations.

The Standards begin with a straightforward statement: Don't violate any laws, rules, or regulations that apply to your professional activities. This includes the Code and Standards, so any violation of the Code and Standards will also violate this subsection.

A member my be governed by different rules and regulations among the Standards, the country in which the member resides, and the country where the member is doing business. Follow the most strict of these, or, put another way, do not violate any of the tree sets of rules and regulations.

If you know that violations of applicable rules or laws are taking place, either by coworkers or clients, CFA Institute strongly encourage members and candidates to report potential violations. One way to do so is approach your supervisor or compliance department to remedy the situation. If they will not or cannot, then you must dissociate from the activity (e.g., not working with a trading group you know is not allocating client trades properly according to the Standard on Fair Dealing, or not using marking materials that you know or should know are misleading or erroneous). If this cannot be accomplished, you may, in an extreme case, has to resign from the firm to be in compliance with this Standard.

Recommendations for Members
  • Establish, or encourage employer to establish, procedures to keep employees informed of changes in relevant laws, rules, and regulation.
  • Review, or encourage employer to review, the firm's written compliance procedures on a regular basis.
  • Maintain, or encourage employer to maintain, copies of current laws, rules, and regulations.
  • When in doubt about legality, consult supervisor, compliance personnel, or a lawyer.
  • When dissociating from violation, keep records documenting the violations, encourage employer to bring an end to the violations.
  • There is no requirement in the Standards to report wrongdoers, but local law may require it; member are "strongly encouraged" to report violations to CFA Institute Professional Conduct Program.
Recommendations for Firms
  • Have a code of ethics.
  • Provide employees with information on laws, rules, and regulations governing professional activities.
  • Have procedures for reporting suspected violations.

Standard I(B) Independence and Objectivity

Members and Candidates must use reasonable care and judgement to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another's independence and objectivity.

Analysts may face pressure or receive inducements to give a security a specific rating, to select certain outside managers or vendors, or to produce favorable or unfavorable research and conclusions. Members who allow their investment recommendations or analysis to be influenced by such pressure or inducements will have violated the requirement to use reasonable care and maintain independence and objectivity in their professional activities. Allocating shares in oversubscribed IPOs to personal accounts is a violation.

Normal business entertainment is permitted. Members who accept, solicit, or offer things of value that could be expected to influence the member's or others' independence or objectivity are violating the Standard. Gifts from clients are considered less likely to compromise independence and objectivity than gifts from other parties. Client gifts must be disclosed to the member's employer prior to acceptance, if possible, but after acceptance, if not.

Members may prepare reports paid for by the subject firm if compensation is a flat rate not tied to the conclusions of the report (and if the fact that the research is issuer-paid is disclosed). Accepting compensation that is dependent on the conclusions, recommendations, or market impact of the report, and failure to disclose that research is issuer-paid, are violations of the Standard.

Recommendations for Members

Members or their firms should pay for their own travel to company events or tours when practicable and limit use of corporate aircraft to trips for which commercial travel is not an alternative.

Recommendations for Firms
  • Restrict employee participation in IPOs and private placements, require pre-approval for participation.
  • Appoint a compliance officer, have written policies on independence and objectivity and clear procedures for reporting violations.
  • Limit gifts, other that from clients, to token items only.

MODULE 3.2: GUIDANCE FOR STANDARD I(C) AND I(D)

Standard I(C) Misrepresentation

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

Misrepresentation includes knowingly misleading investors, omitting relevant information, presenting selective data to mislead investors, and plagiarism. Plagiarism is using reports, forecasts, models, ideas, charts, graphs, or spreadsheets created by others without crediting the source. Crediting the source is not required when using projections, statistics, and tables from recognized financial and statistical reporting services. When using models developed or research done by other members of the firm, it is permitted to omit the names of those who are no longer with the firm as long as the member does not represent work previously done by others as his alone.

Actions that would violate the Standard include:

  • Presenting third-party research as your own, without attribution to the source.
  • Guaranteeing a specific return on securities that do not have an explicit guarantee from government body or financial institution.
  • Selecting a valuation service because it puts the highest value on untraded security holdings.
  • Selecting a performance benchmark that is not comparable to the investment strategy employed.
  • Presenting performance data or attribution analysis that omits account or relevant variables.
  • Offering false or misleading information about the analyst's or firm's capabilities, expertise, or experience.
  • Using marketing materials for a third party (outside advisor) that are misleading.
Recommendations for Members
  • Prepare a summary of experience, qualifications, and services a member is able to perform.
  • Encourage employers to develop procedures for verifying marketing materials provided by third parties concerning their capabilities, products, and services.
  • Cite the source of any summaries of materials provides by others.
  • Keep copies of all reports, articles, or other materials used in the preparation of research reports.
  • Provide a list, in writing, of the firm's available services and qualifications.
  • Periodically review documents and communications of members for any misrepresentation of employee or firm qualifications and capabilities.

Standard I(D) Misconduct

Members and Candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence.

The first part here regarding professional conduct is clear: no dishonesty, fraud, or deceit. The second part, while it applies to all conduct by the member, specifically requires that the act, "reflect adversely on their professional reputation, integrity, or competence." The guidance state, in fact, that members must not try to use enforcement of this Standard against another member to settle personal, political, or other disputes that are not related to professional ethics or competence.

Recommendations for Firms
  • Develop and adopt a code of ethic and make clear that unethical behaviors will not be tolerated.
  • Give employees a list of potential violations and sanctions, including dismissal.
  • Check references of potential employees.

MODULE 3.3: GUIDANCE FOR STANDARD II

STANDARD II: INTEGRITY OF CAPITAL MARKETS

Standard II(A) Material Nonpublic Information

Members and Candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information.

Information is "material" if its disclosure would affect the price of security or if a reasonable investor would want the information before making an investment decision. Information that is ambiguous as to its likely effect on price may not be considered material.

Information is "nonpublic" until it has been made available to the marketplace. An analyst conference call is not public disclosure. Selective disclosure of information by corporations creates the potential for insider-trading violations.

The prohibition against acting on material nonpublic information extends to mutual funds containing the subject securities as well as related swaps and options contracts. It is the member's responsibility to determine if information she receives has been publicly disseminated prior acting or causing others to act on it.

Some members and candidates may be involved in transactions during which they are provided with material nonpublic information by firms(e.g., investment banking transactions). Members and candidates may use this information for its intended purpose, but must not use the information for any other purpose unless it becomes public information.

Under the so-called mosaic theory, reaching an investing conclusion through perceptive analysis of public information combined with non-material nonpublic information is not a violation of the Standard.

Recommendations for Members
  • Make reasonable efforts to achieve public dissemination by the firm of information the possess.
  • Encourage their firms to adopt procedures to prevent the misuse of material nonpublic information.
Recommendations for Firms

Use a firewall within the firm, with elements including:

  • Exercise substantial control of relevant interdepartmental communications.
  • Review employee trades.
  • Maintain "watch," "restricted," and "rumor" lists.

Monitor and restrict proprietary trading while a firm is in possession of material nonpublic information. However, prohibiting all proprietary trading while a firm is in possession of material nonpublic information may be inappropirate because it may send a signal to the market. In these case, firms should only take the opposite side of unsolicited customer trades.

Standard II(B) Market Manipulation

Members and Candidates must not engage in practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.

Member actions may affect security values and trading volumes without violating this Standard. The Key point here is that if there is the intent to mislead, then the Standard is violate. Of course, spreading false information to affect prices or volume is a violation of this Standard as is making trades intended to mislead market participants.

MODULE 3.4: GUIDANCE FOR STANDARDS III(A) AND III(B)

STANDARD III: DUTIES TO CLIENTS

Standard III(A) Loyalty, Prudence, and Care

Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgement. Members and Candidates must act for the benefit of their clients and place their clients' interests before their employer's or their own interests.

Clients interests always come first. Although this Standard dost not impose a fiduciary duty on members or candidates where one did not already exit, it does require members and candidates to at in their clients' best interests and recommend tolerances. Members and candidates must:

  • Exercise the prudence, care, skill, and diligence under the circumstances that a person acting in a like capacity and familiar with such matters would use.
  • Manage pools of client assets in accordance with the terms of the governing documents, such as trust documents or investment management agreements.
  • Make investment decisions in the context of the total portfolio.
  • Inform clients of any limitations in an advisory relationship (e.g., an advisor who may only recommend her own firm's products).
  • Vote proxies in an informed and responsible manner. Due to cost-benefit considerations, it may not be necessary to vote all proxies.
  • Client brokerage, or "soft dollars" or "soft commissions," must be used to benefit the client.
  • The "client" may be the investing public as a whole rather than a specific entity or person.
Recommendations for Members

Submit to client, at least quarterly, itemized statements showing all securities in custody and all debits, credits, and transactions.

Encourage firms to address these topic when drafting policies and procedures regarding fiduciary duty:

  • Follow applicable rules and laws.
  • Establish investment objectives of clients.
  • Consider suitability of a portfolio relative to the client's needs and circumstances, the investment's basic characteristics, or the basic characteristics of the total portfolio.
  • Diversify.
  • Deal fairly with all clients in regard to investment actions.
  • Disclose conflicts.
  • Disclose compensation arrangements.
  • Vote proxies in the best interest of clients and ultimate beneficiaries.
  • Maintain confidentiality.
  • Seek best execution.

Standard III(B) Fair Dealing

Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.

Do not discriminate against any clients when disseminating recommendations or taking investment action. "Fairly" does not mean "equally." In the normal course of business, there will be differences in the time emails, faxs, and other communications are received by different clients.

Different service levels are acceptable, but they must not negatively affect or disadvantage any clients. Disclose the different service levels to all clients and prospects, and make premium levels of service available to all those willing to pay for them.

Give all clients a fair opportunity to act on every recommendation. Clients who are unaware of a change in recommendations for security should be advised of the change before an order for the security is accepted.

Treat clients fairly in light of their investment objectives and circumstances. Treat both individual and institutional clients in a fair and impartial manner. Members and candidates should not take advantage of their position in the industry to disadvantage clients (e.g.,, taking shares of an oversubscribed IPO).

Recommendations for Members

  • Encourage firms to establish compliance procedures requiring proper dissemination of investment recommendations and fair treatment of all customers and clients.
  • Maintain a list of clients and holdings -- use to ensure that all holders are treated fairly.

Recommendations for Firms

  • Limit the number of people who are aware that a change in recommendation will be made.
  • Shorten the time frame between decision and dissemination.
  • Publish personnel guideline for pre-dissemination--have in place guidelines prohibiting personnel who have prior knowledge of recommendation from discussing it or taking action on the pending recommendation.
  • Disseminate new or changed recommendations simultaneously to all clients who have expressed an interest or for whom an investment is suitable.
  • Develop written trade allocation procedures--ensure fairness to clients, timely and efficient order execution , and accuracy of client positions.
  • Disclose trade allocation procedures.
  • Establish systematic account review--ensure that no client is given preferred treatment and that investment actions are consistent with the account's objectives.
  • Disclose available levels of service.

MODULE 3.5: GUIDANCE FOR STANDARDS III(C), III(D), AND III(E)


Standard III(C) Suitability

  1. When Members and Candidates are in an advisory relationship with a client they must:
    1. Make a reasonable inquiry into a client's or prospective client's investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action and must reassess and update this information regularity.
    2. Determine that an investment is suitable to the client's financial situation and consistent with the client's written objectives, mandates, and constraints before making an investment recommendation or taking investment action.
    3. Judge the suitability of investments in the context of the client's total portfolio.
  2. When Members and Candidates are responsible for managing a portfolio to a specific mandate, strategy, or style, they must make only investment recommendations or take only investment actions that are consistent with the state objectives and constraints of portfolio.

In advisory relationships, members must gather client information at the beginning of the relationship, in the form of an investment policy statement (IPS). Consider clients' needs and circumstances and, thus, their risk tolerance. Consider whether or not the use of leverage is suitable for the client.

If a member is responsible for managing a fund to an index or other stated mandate, he must select only investments that are consistent with the stated mandate.

Unsolicited Trade Requests

An investment manager may receive a client request to purchase a security that the manager knows is unsuitable, give the client's investment policy statement. The trade may or may not have a material a material effect on the risk characteristics of the client's total portfolio and the requirements are different for each case. In either case, however, the manager should not make the trade until he has discussed with the client the reasons (based on the IPS) that the trade is unsuitable for the client's account.

If the manager determines that the effect on the risk/return profile of the client's total portfolio is minimal, the manager, after discussing with the client how the trade does not fit the IPS goals and constraints, may follow his firm's policy with regard to unsuitable trades. Regardless of firm policy, the client must acknowledge the discussion and an understanding of the trade is unsuitable.

If the trade would have a material impact on the risk/return profile of the client's total portfolio, one option is to update the IPS so the client accepts a changed risk profile that would permit the trade. If the client will not accept a changed IPS, the manager client-directed account. In the absence of other options, the manager may need to reconsider whether the maintain the relationship with the client.

Recommendations for Members

  • For each client, put the needs, circumstances, and investment objectives into a written IPS.
  • Consider the type of client and whether there are separate beneficiaries, investor objectives (return and risk), investor constraints (liquidity needs, expected cash flows, time, tax, and regulatory and legal circumstances), and performance measurement benchmarks.
  • Review the investor's objectives and constraints periodically to reflect any changes in client circumstances.

Standard III(D) Performance Presentation

When communicating investment performance information. Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.

Members must not misstate performance or mislead clients or prospects about their investment performance or their firm's investment performance.

Members must not misrepresent past performance or reasonably expected performance, and must not state or imply the ability to achieve a rate of return similar to that achieved in the past.

For brief presentations, members must make detailed information available on request and indicate that the presentation has offered only limited information.

Recommendations for Members

  • Encourage firms to adhere to Global Investment Performance Standards.
  • Consider the sophistication of the audience to whom performance presentation is addressed.
  • Present the performance of weighted composite of similar portfolios rather than the performance of a single account.
  • Include terminated accounts as part of historical performance and clearly state when they were terminated.
  • Include all appropriate to disclosures to fully explain results (e.g., model result include, gross or net of fees, etc.).
  • Maintain data and records used to calculate the performance being presented.

Standard III(E) Preservation of Confidentiality

Members and Candidates must keep information about current, former, and prospective clients confidential unless:

  1. The information concerns illegal activities on the part of the client;
  2. Disclosure is required by law; or
  3. The client or prospective client permits disclosure of the information.

If illegal activities by a client are involved, members may have an obligation to report the activities to authorities.

The confidentiality Standard extends to former clients as well.

The requirement of this Standard are not intend to prevent members and candidates from cooperating with a CFA Institute Professional Conduct Program (PCP) investigation.

Recommendations for Members

  • Members should avoid disclosing information received from a client expect to authorized coworkers who are also working for the client.
  • Members should follow firm procedures for storage of electronic data and recommend adoption of such procedures if they are not in place.

MODULE 3.6: GUIDANCE FOR STANDARD IV


STANDARD IV: DUTIES TO EMPLOYERS

Standard IV(A) Loyalty

In matters related to employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.

This Standard is applicable to employees. If members are independent contractors, rather than employees, they have a duty to abide by the terms of their agreements.

Members must not engage in any activities that would injure the firm, deprive it of profit, or deprive it of the advantage of employees' skills and abilities.

Member should always place client interest above interests of their employer, but consider the effect of their actions on firm integrity and sustainability.

There is no requirement that the employee put employer interests ahead of family and other personal obligations; it is expected that employers and employees will discuss such matters and balance these obligations with work obligations.

There may be isolated cases where a duty to one's employer may be violated in order to protect clients or the integrity of the market, when the actions are not for personal gain.

Independent practice for compensation is allowed if a notification is provided to the employer fully describing all aspects of the services, including compensation, duration, and the nature of the activities and the employer consents to all terms of the proposed independent practice before it begins.

When leaving an employer, members must continue to act in their employer's best interests until their resignation is effective. Activities that may constitute a violation include:

  • Misappropriation of trade secrets.
  • Misuse of confidential information.
  • Soliciting employers's clients prior to leaving.
  • Self-dealing.
  • Misappropriation of client list.

Employer records on any medium (e.g., home computer, tablet, cell phone) are the property of the firm.

When an employee has left a firm, simple knowledge of names and existence of the former clients is generally not confidential. There is also no prohibition on the use of experience or knowledge gained while with a former employer. If an agreement exists among employers(e.g., the U.S. "Protocol For Broker Recruiting") that permits brokers to take certain client information when leaving a firm, a member may act within the terms of the agreement without violating the Standard.

Members and candidates must adhere to their employers' policies concerning social media. When planing to leave an employer, members and candidates must ensure that their social media use complies with their employers' policies for notifying clients about employee separations.

Recommendations for Members

Members are encouraged to give their employer a copy of the Code and Standards.

Best practice is use separate social media accounts for personal and professional communications.

Recommendations for Firms

Employers should not have incentive and compensation systems that encourage uneithcal behavior.

Standard IV(B) Additional Compensation Arrangements

Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer's interest unless they obtain written consent from all parties involved.

Compensation includes direct and indirect compensation from a client and other benefits received from third parties.

Written consent from a member's employer includes email communication.

Understand the difference between an additional compensation arrangement and gift from a client:

  • If a client offers a bonus that depends on the future performance of her account, this is an additional compensation arrangement tht requires written consent in advance.
  • If a client offers a bonus to reward a member for her account's past performance, this is a gift that requires disclosure to the member's employer to comply with Standard I(B) Independence and Objectivity.

Recommendations for Members

Make an immediate written report to the employer detailing any proposed compensation and services, if additional to that provide by the employer.

Members and candidates who are hired to work part time should discuss any arrangements that may compete with their employer's interest at the time they are hired and abide by any limitations their employer identifies.

Recommendations for Firms

Details of additional compensation, include any performance incentive, should be verified by the offering party.

Standard IV(C) Responsibilities of Supervisors

Members and Candidates must make reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.

Members must make reasonable efforts to prevent employees from violating laws, rules, regulations, or the Code and Standards, as well as make reasonable efforts to detect violations.

An adequate compliance system must meet industry standards, regulatory requirements, and the requirements of the Code and Standards.

Members with supervisory responsibilities have an obligation to bring an inadequate compliance system to the attention of firm's management and recommend corrective action.

A member or candidate faced with no compliance procedures or with procedures he believes are inadequate must decline supervisory responsibility in writing until adequate procedures are adopted by the firm.

If there is a violation, respond promptly and conduct a thorough investigation while increasing supervision or placing limitation on the wrongdoer's activities.

Recommendations for Members

A member should recommend that his employer adopt a code of ethics. Members should encourage employers to provide their codes of ethics to clients.

Once the compliance program is instituted, the supervisor should:

  • Distribute it to the proper personnel.
  • Update it as needed.
  • Continually educate staff regarding procedures.
  • Issue reminder as necessary.
  • Require professional conduct evaluations.
  • Review employee actions to monitor compliance and identify violations.

Recommendations for Firms

Employers should not commingle compliance procedure with the firm's code of ethics--this can dilute the goal of reinforcing one' ethical obligations.

While investigating a possible breach of compliance procedures, it is appropriate to limit the suspected employee's activities.

Adequate compliance procedures should:

  • Be clearly written.
  • Be easy to understand.
  • Designate a compliance officer with authority clearly defined.
  • Have a system of checks and balances.
  • Outline the scope of procedures.
  • Outline what conduct is permitted.
  • Contain procedures for reporting violations and sanctions.
  • Structure incentive so unethical behavior is not rewarded.

MODULE 3.7: GUIDANCE FOR STANDARD V


STANDARD V: INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS

Standard V(A) Diligence and Reasonable Basis

Members and Candidates must:

  1. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.
  2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.

The application of this Standard depends on the investment philosophy adhered to, members' and candidates' roles in the investment decision-making process, and the resources and support provided by employers. These factors dictate the degree of diligence, thoroughness of research, and the proper level of investigation action required.

The level of research needed to satisfy the requirement for due diligence will differ depending on the product or service offered. A list of things that should be considered prior to making a recommendation or taking investment action include:

  • Global and national economic conditions.
  • A firm's financial results and operating history, and the business cycle stage.
  • Fees and historical results for a mutual fund.
  • Limitations of any quantitative models used.
  • A determination of whether peer group comparison for valuation are appropriate.

Recommendations for Members

Members should encourage their firm to adopt a policy for periodic review of the quality of third-party research. if they have not. Examples of criteria to use in judging quality are:

  • Review assumptions used.
  • Determine how rigorous the analysis was.
  • Identify how timely the research is.
  • Evaluate objectivity and independence of the recommendations.

Members should encourage their firms to consider these policies and procedures support this Standard:

  • Have a policy requiring that research reports and recommendations have a basis that can be substantiated as reasonable an adequate.
  • Have detailed, written guidance for proper research and due diligence.
  • Have measurable criteria for judging the quality of research, and base analyst compensation on such criteria.
  • Have written procedures that provide a minimum acceptable level of scenario testing for computer-based models and include standards for the range of scenarios, model accuracy over time, and a measure of sensitivity of cash flows to model assumptions and inputs.
  • Have a policy for evaluating outside providers of information that addresses the reasonableness and accuracy of the information provided and establishes how often the evaluations should be repeated.
  • Adopt a set of standards that provides criteria for evaluating external advisers and states how often a review of external advisers will be performed.

Standard V(B) Communication With Clients and Prospective Clients

Members and Candidates must:

  1. Disclose to clients and prospective clients the basic format and general principles of the investment processes they use to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes.
  2. Disclose to clients and prospective clients significant limitations and risks associated with the investment process.
  3. Use reasonable judgement in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients.
  4. Distinguish between fact and opinion in the presentation of investment analyses and recommendations.

All means and types of communication with clients are covered by this Standard. not just research reports or other written communications.

Members must distinguish between opinions and facts and always include the basic characteristics of the security being analyzed in a research report. Expectations based on statistical modelling and analysis are not facts.

Members must explain to clients and prospects the investment decision-making process used.

In preparing recommendations for structured securities, allocation strategies, or any other nontraditional investment, members must communicate those risk factors specific to such investments. In all cases, members should communicate the potential gains and losses on the investment clearly in terms of total returns.

Members must communicate significant changes in the risk characteristics of an investment or investment strategy

Members must update client regularly about any changes in the investment process, including any risks and limitations that have been newly identified.

When using projections from quantitative models and analysis, members may violate the Standard by not explaining the limitation of the model and the assumptions it uses, which provides a context for judging the uncertainty regarding the estimated investment result.

Members and candidates must inform clients about limitation inherent to an investment. Two examples of such limitations are liquidity and capacity. Liquidity refers to the ability to exit an investment readily without experiencing a significant extra cost from doing so. Capacity refers to an investment vehicle's ability to absorb additional investment without reducing the returns it is able to achieve.

Recommendations for Members

Selection of relevant factors in a report can be a judgement call so members should maintain records indicating the nature of the research, and be able to supply additional information if it is requested by the client or other users of the report.

Standard V(C) Record Retention

Members and Candidates must develop and maintain appropriate records to support their investment analyses, recommendations, actions, and other investment-related communications with client and prospective clients.

Members must maintain research records that support the reasons for the analyst's conclusions and any investment action taken. Such records are the property of the firm. All communications with clients through any medium, including emails and text messages, are records that must be retains.

A member who changes firms must re-create the analysis documentation supporting her recommendations using publicly available information or information obtained from the company and must not rely on memory or material created at her previous firm.

Recommendations for Members

If no regulatory standards or firm policies are in place, the Standard recommends a seven-year minimum holding period.

Recommendation for Firms

This recodkeeping requirement generally is the firm's responsibility.

MODULE 3.8: GUIDANCE FOR STANDARD VI


STANDARD VI: CONFLICTS OF INTEREST

Standard VI(A) Disclosure of Conflicts

Members and Candidates must make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer. Members and Candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.

Members must fully disclose to clients, prospects, and their employers all actual and potential conflicts of interest in order to protect investors and employers. These disclosure must be clearly stated.

The requirement that all potential areas of conflict be disclosed allows clients and prospects to judge motives and potential biases for themselves. Disclosure of broker-dealer market-making activities could be included here. Board service is another area of potential conflict.

The most common conflict that requires disclosure is actual ownership of stock in companies that the member recommends or that clients hold.

Another common source of conflicts of interest is a member's compensation/bonus structure, which can potentially create incentives to take actions that produce immediate gains for the member with little or no concern for longer-term returns for the client. Such conflicts must be disclosed when the member is acting in an advisory capacity and must be updated in the case of significant change in compensation structure.

Members must give their employers enough information to judge the impact of a conflict, take reasonable steps to avoid conflicts, and report them promptly if they occur.

Recommendations for Members

Any special compensation arrangements, bonus programs, commissions, and incentive should be disclosed.

Standard VI(B) Priority of Transactions

Investment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner.

Client transactions take priority over personal transactions and over transactions made on behalf of the member's firm. Personal transactions include situations where the member is a beneficial owner.

Personal transactions may be undertaken only after clients and the member's employer have had an adequate opportunity to act on a recommendation. Note that family member accounts that are client accounts should be treated just like any client account; they should not be disadvantaged.

Members must not act on information about pending trades for personal gain. The overriding considerations with respect to personal trade are that they do not disadvantage any clients.

When requested, members must fully disclose to investors their firm's personal trading policies.

Recommendations for Members

Members can avoid conflicts that arise with IPOs by not participating in them.

Members should encourage their firms to adopt the procedures listed in the following recommendations for firms if they have not done so.

Recommendations for Firms

All firms should have basic procedures in place that address conflicts created by personal investing. The following areas should be include:

  • Establish limitations on employee participation in equity IPOs.
  • Establish restrictions on participation in private placements. Strict limits should be placed on employee acquisition of these securities and proper supervisory procedures should be in place. Participation in these investments raises conflict or interest issues similar to those of IPOs.
  • Establish blockout/restricted periods. Employees involved in investment decision making should have blackout periods prior to trading for clients--no front running (i.e., purchase or sale of securities in advance of anticipated client or employer purchases and sales). The size of firm and type of security should help dictate how severe the blackout requirement should be.
  • Establish reporting procedures, including duplicate trade confirmations, disclosure of personal holdings and beneficial ownership positions, and preclearance procedures.

Standard VI(C) Referral Fees

Members and Candidates must disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.

Members must inform employers, clients, and prospects of any benefit received for referrals of customers and clients, allowing them to evaluate the full cost of the service as well as any potential partiality. All types of consideration must be disclosed.

Recommendations for Members

Members should encourage their firms to adopt clear procedures regarding compensation for referrals.

Members should provide their employers with updates at least quarterly.

Recommendations for Firms

Firms that do not prohibit referral fees should have clear procedures for approval and policies regrading the nature and value of referral compensation received.

MODULE 3.9: GUIDANCE FOR STANDARD VII


STANDARD VII: RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE

Standard VII(A) Conduct as Participants in CFA Institute Programs

Members and Candidates must not engage in any conduct that compromises the reputations or integrity of CFA Institute or the CFA designation or the integrity , validity, or security of CFA Institute programs.

Members must not engage in any activity that undermines the integrity of the CFA charter. This Standard applies to conduct that includes:

  • Cheating on the CFA exam or any exam.
  • Revealing anything about either broad or specific topics tested, content of exam questions, or formulas required or not required on the exam.
  • Not following rules and policies of the CFA Program.
  • Giving confidential information on the CFA Program to candidates or the public.
  • Improperly using the designation to further personal and professional goals.
  • Misrepresenting information on the Professional Conduct Statement (PCS) or the CFA Institute Professional Development Program.

Members and candidates are not precluded from expressing their opinions regarding the exam program or CFA Institute but must not reveal confidential information about the CFA Program.

Candidates who violate any of the CFA exam policies (e.g., calculator, personal belongings, Candidate Pledge) have violated Standard VII(A).

Members who volunteer in the CFA Program may not solicit or reveal information about questions considered for or included on a CFA exam, about the grading process, or about scoring of questions.

Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program

When referring to CFA Institute, CFA Institute membership, the CFA designation, or candidancy in the CFA Program, Members and Candidates must not misrepresent or exaggerate the meaning or implications of the membership in CFA Institute, holding the CFA designation, or candidacy in the CFA Program.

Members must not make promotional promises or guarantees tied to the CFA designation, such as over-promising individual competence or over-promising investment results in the future (i.e., higher performance, less risk, etc.).

Members must satisfy these requirements to maintain membership:

  • Sign the PCS annually.
  • Pay CFA Institute membership dues annually.

If they fail to do this, they are no longer active members.

Do not misrepresent or exaggerate the meaning of the CFA designation.

There is no partial CFA designation. It is acceptable to state that a candidate successfully completed the program in three years if, in fact, he did, but claiming superior ability because of this is not permitted.

Recommendations for Members

Members should be sure that their firms are aware of the proper references to a member's CFA designation or candidacy, as errors in these references are common.