Answers - Professional Conduct Standards III

Question #1 of 75 Question ID: 1474255 Caroline Turner, an analyst for Lansing Asset Management, just completed an investment report in which she recommends changing a "buy" to a "sell" for Gallup Company. Her supervisor at Lansing approves of the change in recommendation. Turner wonders about whether she needs to disseminate this investment recommendation to Lansing's clients and if so, how to distribute this information. According to CFA Institute Standards of Professional Conduct, Turner is: A) B) C) required to disseminate the change in a prior investment recommendation to all clients and customers on a uniform basis. required to design an equitable system to disseminate the change in a prior investment recommendation. not required to disseminate the change of recommendation from a buy to a sell because the change is not material. Explanation Standard III(B) – Fair Dealing requires dealing fairly and objectively with all clients and prospects when disseminating material changes in prior investment recommendations. Note that the standard requires the dissemination be fair, but not necessarily equal due to the impossibility of contacting all clients simultaneously. A change of recommendation from "buy" to "sell" is generally material. (Module 43.5, LOS 43: III(B)) Question #2 of 75 Question ID: 1474252 Pro rata allocation on the basis of an advance indication of interest means each account for which the shares are suitable: and which has expressed an advance indication of interest, shall receive w*m A) shares, where w is the account's proportional value of all such accounts and there are m shares available. and which has expressed an advance indication of interest, shall receive m/n B) fraction of their indication, where there are m shares available and indications of interest for n shares. C) shall receive m/n shares, where there are m shares available and n such accounts. Explanation Pro rata allocation on the basis of an advance indication of interest means that all accounts that have expressed an interest in the issue shall receive m/n fraction of their indication of interest, where there are m shares available and indications of interest for n shares. (Module 43.5, LOS 43: III(B)) Question #3 of 75 Question ID: 1474209 Jack Stevens is employed by a company to provide investment advice to participants in the firm's 401(k) plan. One of the investment options is a stable value fund run by the company. Stevens' research indicates that the fund is far riskier and less liquid than the typical stable value fund and has a fundamental asset value lower than the book value of the assets. He tells Jessica Cox, the head of employee benefits, about his research, and indicates that he will advise new employees to not invest in the fund and will advise employees who already own the fund to reduce their holdings in the fund. Cox points out that the fund is not in any current danger because there are very few redemptions requested of the fund. Cox also states that a sell recommendation may become a self fulfilling prophecy, causing investors to redeem their shares and forcing the fund to liquidate, which in turn will cause the remaining investors to receive less than their promised value. Stevens agrees with this assessment and feels his fiduciary duty is to all employees. Stevens should: A) B) continue to recommend that new investors do not invest in the fund, but not advise existing investors to reduce their holdings. continue to recommend that new investors do not invest in the fund and existing investors reduce their holdings. C) tell investors he cannot give advice on the fund because of a conflict of interest. Explanation The employees to whom Stevens owes fiduciary duty are the ones who are seeking his advice, even if acting on that advice hurts other employees who might eventually become clients. (Module 43.4, LOS 43.a) Question #4 of 75 Question ID: 1474225 An independent analyst has only one client. One of the client's largest holdings is a brokerage firm. Because of the large holding by his client, the brokerage firm recently began allowing the analyst to tap into the firm's computer network to use the firm's research facilities. This is allowable as long as the analyst: A) does both of the actions listed here. B) discloses the relationship to the client. C) uses the resources to help manage the client's account. Explanation According to Standard III(A), Loyalty, Prudence, and Care, the analyst must put the client first and inform the client of any possible conflicts of interest. The analyst must channel any benefits derived from his service to the client, back to the client, and inform the client of the benefits. (Module 43.4, LOS 43: III(A)) Question #5 of 75 Question ID: 1474239 An investment advisor goes straight from a research seminar to a meeting with a prospective new client with whom she has never been in contact. The advisor is very excited about the information she just received in the seminar and begins showing the prospect the new ideas her firm is coming up with. This is most likely a violation of: A) Standard III(C), Suitability. B) Standard III(B), Fair Dealing. C) both of these. Explanation It is a violation of Standard III(B) because the advisor should act first on behalf of existing clients whose needs and characteristics she already knows. It is a violation of Standard III(C) because she has never met the prospect and does not know if the new ideas are appropriate for the prospect. Thus, "both of these" is the best response. (Module 43.5, LOS 43: III(B)) Question #6 of 75 Question ID: 1474215 Denise Weaver is a portfolio manager who manages a mutual fund and has pension clients. When Weaver receives a proxy for stock in the mutual fund, she gives it to Susan Griffith, her administrative assistant, to complete. When the proxy is for a stock owned in a pension plan, she asks Griffith to send the proxy on to the sponsor of the pension fund. Weaver has: A) violated the Standards by her policy on mutual fund and pension fund proxies. B) not violated the Standards. C) violated the Standards by her policy on mutual fund proxies, but not her policy on pension fund proxies. Explanation Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor's interests will not always be the same as the beneficiary's interest. (Module 43.4, LOS 43.b) Question #7 of 75 Question ID: 1474258 Lance Tuipulotu, CFA, manages investments for 400 individuals and families and often finds his resources stretched. When his largest investors petition him to include a 5% to 7% allocation of non-investment-grade bonds in their portfolios, he decides he needs additional help to meet the request. He considers various independent advisors to use as submanagers, but determines that the most qualified advisors would be too expensive. Reasoning that a lower-cost provider would enable him to pass the savings along to his clients, he chooses that provider to invest the new bond allocation. Tuipulotu has violated: A) B) C) Standard III(C) Suitability by failing to consider the appropriateness of the noninvestment-grade bonds. Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis. Standard V(A) Diligence and Reasonable Basis by letting fee structure determine the selection of the submanager. Explanation Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis were violated. Tuipulotu must perform a full IPS review to determine the appropriateness of the new portfolio allocations. Submanagers should not be selected by cost structure alone, as the quality and appropriateness of the submanager is Tuipulotu's responsibility. (Module 43.5, LOS 43: III(C)) Question #8 of 75 Question ID: 1474259 Janet Reilly has just approached Betty Miller, CFA, about purchasing 10,000 shares of Brookshire Co., a newly incorporated real estate development firm. Reilly is a retired schoolteacher living off the income from her late husband's life insurance policy. This investment will represent a significant shift in her investment portfolio. Miller believes this trade is unsuitable with respect to Reilly's investment policy statement. Consistent with the Standards, Miller should most appropriately: A) follow her firm’s procedures for obtaining Reilly’s approval to carry out the unsolicited trade request. B) not accept the order, because it is not a suitable investment for Reilly. C) discuss with Reilly whether she wishes to update her investment policy statement. Explanation According to the guidance for Standard III(C) Suitability, a member who receives an unsolicited trade request that is not suitable for the client should discuss the trade with the client before carrying it out. The nature of this discussion depends on whether the trade has a material effect on the client's portfolio. Because this trade will have a material effect, Miller's most appropriate action is to discuss with the client whether this trade request reflects a change in her investment objectives and risk tolerance and thus whether she wishes to update her IPS. (Module 43.5, LOS 43: III(C)) Question #9 of 75 Question ID: 1474246 Rickard Advisors recently had a trading error in a customer account that was subsequently discovered by Rickard. The firm felt embarrassed by the disclosure of this error, and, in order to induce the client to continue its relationship, Rickard offers the client preferential access to a new issue that is expected to be "hot." Which Standard is violated, if any? A) The Standard concerning Fair Dealing. B) The Standard concerning Fiduciary Duty. C) The Standard concerning Independence and Objectivity. Explanation Rickard is in violation of the Standard concerning Fair Dealing by offering the client preferential access to a "hot" new issue. There is no obvious violation of Fiduciary Duty, since there is no evidence that Rickard is placing its own financial interest ahead of the client. (Module 43.5, LOS 43: III(B)) Question #10 of 75 Question ID: 1474243 Which of the following statements is least accurate regarding being a part of Standard III(B), Fair Dealing? A) Shorten the time between decision and dissemination. B) At the same time notify clients for whom an investment is suitable of a new investment recommendation. C) Maintain a list of clients and their holdings. Explanation All of these are part of Standard III(B) except notifying clients at the same time. Standard III(B) states that clients for whom the investment is suitable should be notified at approximately the same time. (Module 43.5, LOS 43: III(B)) Question #11 of 75 Question ID: 1474212 A company has a defined benefit plan that is currently under-funded. The plan sponsor has instructed the portfolio manager of the plan to invest more aggressively to bring the funding level up to an adequate amount. Which of the following statements best describes the course of action the portfolio manager should take? The portfolio manager should: A) not invest more aggressively because this is not the method used to increase the funding level of a plan. B) not invest more aggressively since this may expose the plan to too much risk and may not be in the best interest of the plan's beneficiaries. C) invest more aggressively because his fiduciary duties lie with the plan sponsor. Explanation Standard III(A), Loyalty, Prudence, and Care, applies in this situation. According to this Standard, investment actions should be carried out for the sole benefit of the client and in a manner the manager believes to be in the best interest of the client. Here, the client is the plan beneficiaries, not the manager or the entity that hired the manager. (Module 43.4, LOS 43.b) Question #12 of 75 Question ID: 1474211 All of the following would be effective components of a formal compliance system EXCEPT: A) the investor's objectives and constraints should be maintained and reviewed periodically to reflect any changes in the client's circumstances. the firm prohibits analysts and portfolio managers from using material B) nonpublic information in making investment recommendations or taking investment action. as a fiduciary under ERISA, the firm will strictly follow pension plan instructions C) and restrictions, which may include concentrating portfolios in a few securities or industries. Explanation According to Standard III(A)—Loyalty, Prudence, and Care, "members shall use particular care in determining applicable fiduciary duty." Under ERISA, a fiduciary has the duty to diversify the plan's investments in order to protect it from the risk of substantial loss. The firm must follow pension plan instructions and restrictions unless they conflict with ERISA or other applicable laws and regulations. Having concentrated portfolios does not constitute effective diversification. An appropriate policy statement would be: " The firm will follow pension plan documents only to the extent that they are consistent with applicable laws and regulations. The firm will diversify plan assets to minimize the risk of loss." (Module 43.4, LOS 43.a) Question #13 of 75 Question ID: 1474268 With regard to Global Investment Performance standards (GIPS), if the Chief Investment Officer of an investment advisory firm also is a CFA charterholder: A) the charterholder is required to comply with GIPS. B) the firm is required to comply with GIPS. C) neither the firm nor the charterholder are required to comply with GIPS. Explanation Adoption of GIPS is voluntary for firms. GIPS apply to firms, not individuals. (Module 43.6, LOS 43.b) Question #14 of 75 Question ID: 1474275 Greg Stiles, CFA, may withhold from CFA Institute information about a client acquired in the regular performance of his duties: A) for neither of the reasons listed. B) only if Stiles has a special confidentiality agreement with the client. C) only if Stiles is a relative of the client. Explanation According to Standard III(E), Preservation of Confidentiality, Stiles may not withhold information under any of the listed reasons. The reason is that CFA Institute will keep the information confidential. (Module 43.6, LOS 43: III(E)) Question #15 of 75 Question ID: 1474218 All of the following are required by fiduciaries under Standard III(A), Loyalty, Prudence, and Care, EXCEPT: A) act solely in the interest of the ultimate beneficiaries. B) place the client’s interest before the employer’s interest. C) support the sponsor's management during proxy fights. Explanation Members are required to act in the interest of their clients. In voting proxies, the client's interest must prevail over management's interest. (Module 43.4, LOS 43: III(A)) Question #16 of 75 Question ID: 1474222 Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades for the fund with Canadian Brokerage. Canadian provides Calaveccio with soft dollars to purchase research. He uses these soft dollars to get research reports from Canadian's research department regarding the issues currently held in the small cap portfolio, and also for firms he is contemplating adding to the portfolio. By using soft dollars in this manner, Calaveccio has: violated the Code and Standards by acquiring research on issues that the fund A) already holds but not by acquiring research on issues contemplated for purchase. B) violated the Code and Standards by acquiring research on issues contemplated for purchase but not by acquiring research on currently held issues. C) not violated the Code and Standards. Explanation "Soft dollars" are the property of the client (in this case the holders of the shares of the Small Cap Venture Fund). Standard III(A) Loyalty, Prudence, and Care delineates the member's responsibilities. Since he is clearly using the soft dollars to obtain research that is directly applicable to his professional duties, there is no violation of the Standard. (Module 43.4, LOS 43: III(A)) In August 2005, the following events occurred related to Aggregate Opportunities, Inc.: Aug. 8: The Wall Street Journal reported that Aggregate Opportunities had inflated its 2004 earnings due to questionable accounting practices. The story was based on interviews with unnamed sources within Aggregate and its auditor, Millennium Partners. On that day the stock fell 42 percent to $12.50 from $21.55. Aug. 10: At 9 a.m., Aggregate revealed in a conference call to analysts a restatement of earnings for the previous three fiscal years that almost completely erased the reported net income for fiscal years 2002, 2003, and 2004. Aggregate's chief financial officer personally selected the small group of analysts participating in this call. Company officers said the restatement resulted from questionable accounting practices for off-balance sheet limited partnerships. At 1 p.m., the company issued a news release containing the information provided in the conference call. By the end of the trading day the stock had fallen 74 percent to $3.25. Aug. 11: At 10 a.m., Aggregate's Chief Financial Officer Buster Lockhart, CFA, publicly announced his resignation, and the Securities and Exchange Commission said it was pursuing an investigation. During July and August of 2005, the following actions were taken: July 20: Michael Cho, CFA, a highly respected analyst with 25 years of experience covering Aggregate's industry, had spent several days reading Aggregate's 10-K and 10-Q documents and other analysis published by some of his competitors at major brokerage houses. Based on his reading and conversations with Aggregate management concerning nonmaterial, nonpublic information, Cho concluded that Aggregate had inflated its earnings. On July 20, Cho issued a detailed research report to his clients and concluded that Aggregate should be sold. He subsequently participated in the Aug. 10 conference call, although it only confirmed what he had already detailed in his July research report. Aug. 2: Equity analyst Harold Black, a CFA charterholder, received from his brother information that Aggregate might restate its earnings. Black's brother is a senior partner at Millennium Partners. Based on this information, Black immediately prepared a new research report that advised his clients to sell Aggregate, but did not liquidate his personal holdings in the company. Aug. 4: Bob Watkins, a CFA Level II candidate and portfolio manager, was golfing at his club. Approaching the third tee, he heard the chief executive officer and chief financial officer of Aggregate discussing company finances. Concealing himself behind a tree, Watkins overheard them discussing the upcoming Wall Street Journal article and the earnings restatement. Based on this conversation, he immediately sold all Aggregate holdings in his clients' portfolios. Later that day, Watkins told his friend Juan Martinez, CFA, what he learned about Aggregate and how he learned it. Martinez, a subscriber to Cho's research, then read Cho's report on Aggregate. Immediately after finishing Cho's report, Martinez sold the fund's entire stake in Aggregate. Watkins and Martinez were not participants in the Aug. 10 conference call. Aug. 8: Barb Henderson, a CFA charterholder, read the Wall Street Journal article in the morning and after going over her research papers, issued a sell recommendation for Aggregate. On Aug. 10, she participated in the conference call and heard the details of the earnings restatement. Aug. 10: Lisa Sanders, CFA, participated in the Aggregate conference call. At 10 a.m., she changed her recommendation on Aggregate from hold to sell and informed all of her clients. At 1 p.m., Sanders sold Aggregate from her personal account. Question #17 - 20 of 75 Question ID: 1474231 In selling his clients' holdings in Aggregate, Watkins: A) B) C) did not violate Standard II(A): Material Nonpublic Information because the information did not involve a tender offer. violated Standard II(A): Material Nonpublic Information by taking investment action. did not violate Standard II(A): Material Nonpublic Information because there was no breach of duty. Explanation Watkins violated the CFA Institute Standards because the information was both material and nonpublic. It does not matter if the information was not misappropriated, not received in a breach of duty or not related to a tender offer. Watkins still cannot trade or cause others to trade. CFA candidates are indeed subject to the CFA Institute Standards. While the misappropriated information did not involve a tender offer, Watkins' use of it still violated the Standards simply because it was material nonpublic information. (Module 43.3, LOS 43.a) Question #18 - 20 of 75 Question ID: 1474232 After changing her recommendation on Aggregate, Sanders: A) B) C) violated Standard VI(B): Priority of Transactions by trading Aggregate from her own account. violated Standard II(A): Material Nonpublic Information by taking investment action based on information not accessible to the public. did not violate Standard II(A): Material Nonpublic Information because the information was disclosed to a select group of analysts. Explanation The way in which Aggregate handled the conference call was an instance of selective dissemination, Members and Candidates must be aware that disclosure to selected analysts is not necessarily public disclosure. Thus, until the material information is made public, Sanders cannot trade or cause others to trade. Once the information is made public, Sanders must disseminate the information to her clients first, and give them adequate time to act on the recommendation before trading for her own account. In the absence of knowledge of any company policy with stricter requirements, 3 hours is probably sufficient, and we cannot assume she violated Standard VI(B). Standard III(B) does not require equal dissemination of information but rather fair dissemination. Nothing in the question indicated that Sanders disseminated the information unfairly. (Module 43.3, LOS 43.a) Question #19 - 20 of 75 Question ID: 1474233 In selling his fund's stake in Aggregate, Martinez: A) violated Standard III(A): Loyalty, Prudence, and Care by using information obtained from Watkins. B) violated no standards. C) violated Standard II(A): Material Nonpublic Information by using information obtained from Watkins. Explanation Martinez was aware of how Watkins obtained the information; therefore, Martinez violated II(A) by trading on material nonpublic information. Martinez has no fiduciary duty to Watkins, and as such did not violate Standard III(A). It would be difficult to argue that Cho's thorough research is not sufficient reason to trade Aggregate stock, so Martinez did not violate Standard V(A). (Module 43.3, LOS 43.a) Question #20 - 20 of 75 Question ID: 1474234 Which statement about violations of the Code and Standards is CORRECT? A) Henderson violated the reasonable-basis standard, but Sanders did not violate the Standard regarding use of material nonpublic information. B) C) Aggregate’s CFO violated the fair-dealing Standard, but Black did not violate the fiduciary-duties Standard. Martinez did not violate the Standard regarding use of material nonpublic information and did not violate the fiduciary-duties standard. Explanation Aggregate's selective disclosure did violate the fair-dealing Standard, and while Black violated a number of Standards, his brother's fiduciary duty cannot be imposed on him. Black did not violate the fiduciary-duties Standard. While Cho did not violate the insidertrading standard because he came to his conclusions through the mosaic method, Watkins certainly did because he misappropriated the information. Martinez violated the Standard on material nonpublic information. Henderson did not violate the reasonable-basis Standard. Sanders did violate the insider-trading Standard. (Module 43.5, LOS 43.a) Question #21 of 75 Question ID: 1474249 Which of the following statements is least accurate? It is permissible under the Standards to allocate trades: A) on a pro rata basis over all accounts. B) on a pro rata basis over all suitable accounts on the basis of an advance indication of interest and indicated order size. C) on a pro rata basis over all suitable accounts based upon account value. Explanation Allocating trades on a pro rata basis, pro rata based upon order size (when there are too few shares to fill all orders, e.g., filling 2/3 of all orders actually submitted), or pro rata based upon an advance indication of interest are all permissible. However, accounts must be checked for suitability. (Module 43.5, LOS 43: III(B)) Question #22 of 75 Question ID: 1474273 A money manager is meeting with a prospect. She gives the client a list of stocks and says, "These are the winners I picked this past year for my clients. Their double-digit returns indicate the type of returns I can earn for you." The list includes stocks the manager had picked for her clients, and each stock has listed with it an accurately measured return that exceeds 10%. Is this a violation of Standard III(D), Performance Presentation? A) Yes, because the manager cannot reveal historical returns of recent stock picks. B) No, because the manager had the historical information in writing. C) Yes, unless the positions listed constitute a complete presentation (i.e., there were no stocks omitted that did not perform in the double digits). Explanation Standard III(D) requires fair representations concerning past and potential future performance. Unless the list of the "winners" includes all the positions that the firm held, the manager is misrepresenting past performance. The following statement is questionable: "Their double-digit returns indicate the type of returns I can earn for you," but the action of submitting a partial list is clearly a violation. The manager should have information on past performance in writing. (Module 43.6, LOS 43: III(D)) Question #23 of 75 Question ID: 1474236 Steven Wade, CFA, writes an investment newsletter focusing on high-tech companies, which he distributes by e-mail to paid subscribers. Wade does not gather any information about his clients' needs and circumstances. Wade has developed several complex valuation models that serve as the basis for his recommendations. Each month, his newsletter contains a list of "buy" and "sell" recommendations. He states that his recommendations are suitable for all types of portfolios and clients. Because of their proprietary nature, Wade does not disclose, except in general terms, the nature of his valuation models. He conducted numerous statistical tests of these models and they appear to have worked well in the past. In his newsletter, Wade claims that subscribers who follow his recommendations can expect to earn superior returns because of the past success of his models. Wade violated all of the following CFA Institute Standards of Professional Conduct EXCEPT: A) Standard III(B), Fair Dealing. B) Standard V(B), Communication with Clients and Prospective Clients. C) Standard I(C), Misrepresentation. Explanation Wade did not violate Standard III(B), Fair Dealing, because this situation does not indicate that he failed to deal fairly and objectively with all clients when disseminating his newsletter containing investment recommendations. Wade violated Standard V(B), Communication with Clients and Prospective Clients, because he failed to include all relevant factors behind his recommendations. Without providing the basis for his recommendations, clients cannot evaluate the limitations or the risks inherent in his recommendations. Wade violated Standard I(C), Misrepresentation, because his claims about gaining superior expected returns are misleading to potential investors. (Module 43.5, LOS 43.b) Question #24 of 75 Question ID: 1474207 Which of the following statements about soft dollars is least accurate? A) Directed brokerage are soft dollars to be used for research that benefits the investment firm. B) Soft dollars are third party research arrangements. C) Soft dollars are assets of the client. Explanation Directed brokerage are soft dollars directed by the client to the investment manager to pay for goods and services that benefits the client only and not the firm. (Module 43.4, LOS 43.a) Question #25 of 75 Question ID: 1474256 Bob Hatfield, CFA, has his own money management firm with two clients. The accounts of the two clients are equal in value. One of the clients gets married and the assets of the new spouse and the client are combined. With the larger portfolio of the now married client, Hatfield determines that they can assume a higher level of risk and begins a change in the policy concerning that portfolio. Which of the following would violate Standard III(C), Suitability? A) Implement a similar policy for the other client who did not just get married. B) Assess the time horizon of the newly married client and his spouse. C) Assess the return objectives of the newly married client and his spouse. Explanation According to Standard III(C), Suitability, the analyst must assess the time horizon, return objectives, tax considerations, and liquidity needs of a client before changing an investment policy. The analyst must notify the client of the new policy. Implementing the policy for the other client may be a violation of the Standard unless that client's needs are totally reassessed and determined to be identical to the needs of the newly married client. (Module 43.5, LOS 43: III(C)) Question #26 of 75 Question ID: 1474238 Maggie McCarthy is an individual investment advisor who uses mutual funds for her clients. She typically chooses from a list of 40 funds that she has thoroughly researched. The Figgs, a married couple that are a client, asked her to consider the Boilermaker fund for their portfolio. McCarthy had not previously considered the fund because when she first conducted her research three years ago, Boilermaker was too small to be considered. However, the fund has now grown in value, and after doing thorough research on Boilermaker, she found the fund was by far the most outstanding large company value fund in her list of funds. She puts the fund in the Figgs' portfolio, and in all new clients' portfolios, but not in any of her other clients' portfolios. Her reasoning is that her existing clients were comfortable with their current holdings, and she did not want to risk disturbing their comfort. Has McCarthy violated any Standards? McCarthy has: A) violated the Standards by not having a reasonable and adequate basis for making the recommendation. B) violated the Standards by not dealing fairly with clients. C) not violated the Standards. Explanation The fund should have been considered for the existing clients' portfolios. There may have been reasons not to add the fund to their portfolios, such as tax consequences or a lack of suitability, but disturbing their comfort is not sufficient. (Module 43.5, LOS 43.b) Question #27 of 75 Question ID: 1474276 Greg Stiles, CFA, keeps a list of his clients' birthdays and has personally sent them a birthday card each year at the appropriate time. With respect to this action, which of the following may be a violation of Standard III(E), Preservation of Confidentiality? A) Hiring a company outside the firm to perform the task. B) The mere act of sending a birthday card each year. C) Sending a gift along with the card. Explanation According to Standard III(E), an analyst should limit the number of persons who have access to clients' personal information. Allowing a company outside the firm to send birthday cards could be a violation. Sending a birthday card is not a violation, nor is sending a gift of reasonable value. (Module 43.6, LOS 43: III(E)) Question #28 of 75 Question ID: 1474274 While servicing his clients' accounts, an analyst who is a CFA charterholder, determines that one client is probably involved in illegal activities. According to Standard III(E), Preservation of Confidentiality, the analyst may NOT do which of the following? A) There are no exceptions in this list. B) Contact the appropriate governmental authorities about the determination. C) Contact CFA Institute about the determination. Explanation Standard III(E) allows an analyst to reveal information about a client to CFA Institute since CFA Institute will keep the information confidential. If the analyst is reasonably certain a law has been violated, an analyst may have an obligation to report the activities to the appropriate authorities. Therefore, neither of the listed actions are exceptions from the analyst's options. (Module 43.6, LOS 43: III(E)) Question #29 of 75 Question ID: 1474205 Perley & Sons is an investment advisor company that just signed a contract with full discretionary power for the management of assets for Bright Future, a charitable fund. Without consultation, portfolio manager Martin Brown, CFA, decides to trade the funds' assets through a brokerage firm that provides, as an additional benefit, research reports for companies in the microchip industry. These companies represent the main investment interest for most of the Perley & Sons clients. The Bright Future portfolio does not hold any equities in the microchip industry, and, because of its risk profile, is unlikely to ever do so. Which of the following activities represents a possible breach with the CFA Institute standards? A) B) Exercising a selection principle that does not comply with the idea of best trade price and execution. Accepting research reports from the brokerage firm that do not benefit client portfolios. C) Lack of action in consulting with the client before choosing the brokerage firm. Explanation The problem refers to the fiduciary duties of the analyst and brokerage contracts involving soft money. Trades placed with a broker that provides the firm with research are implicitly paying for the research. In a competitive marketplace, it is probable that the trades could have been as effectively placed with a broker that was able to provide research that would apply to the holdings of Bright Future. According to Standard III(A) Loyalty, Prudence, and Care, it is permissible to direct trades of the client portfolio through a broker who provides research that does not directly benefit the client portfolio, but the client should be informed about the situation. (Module 43.4, LOS 43.a) Question #30 of 75 Question ID: 1474242 A money management firm has the following policy concerning new recommendations: When a new recommendation is made, each portfolio manager estimates the likely transaction size for each of their clients. Clients are notified of the new recommendation in the order of their estimated transaction size—largest first. All clients have signed a form where they acknowledge and consent to this allocation procedure. With respect to Standard III(B), Fair Dealing, this is: A) not a violation because the clients are aware of the policy. B) not a violation because the clients have signed the consent form. C) a violation of the standard. Explanation Such a policy is a violation of the Standard and client acknowledgement and/or consent does not change that fact. (Module 43.5, LOS 43: III(B)) Question #31 of 75 Question ID: 1474278 Calvin Doggett, CFA, has been contacted by the CFA Institute Professional Conduct Program (PCP) regarding allegations that he has taken investment actions that were unsuitable for his clients. Doggett is questioned by PCP concerning the identity of his clients he considered suitable for investing in a very risky start-up company that eventually went bankrupt. Doggett will: A) not violate the Code and Standards by revealing the names, financial condition and investment objectives of his clients to PCP. not violate the Code and Standards only if he reveals the financial condition and B) investment objectives of his clients on an anonymous basis and does not reveal the names of his clients to PCP. C) violate the Code and Standards by fully cooperating with a PCP investigation if it means revealing confidential information. Explanation Standard III(E) requires members to preserve client confidentiality. An exception to this standard is a PCP investigation. Because PCP will also keep the clients' information confidential, members are expected to fully cooperate with PCP investigations. (Module 43.6, LOS 43: III(E)) Question #32 of 75 Question ID: 1474279 A CFA charterholder may disclose confidential information about a client when: A) the information is nonmaterial. B) the CFA Institute Professional Conduct Program requests it. C) it is a necessary step in proceeding with research on client preferences. Explanation According to Standard III(E), Preservation of Confidentiality, a CFA charter holder cannot discuss client information received in the process of performing services for them except when related to an illegal action or when requested by the CFA Institute Professional Conduct Program. (Module 43.6, LOS 43: III(E)) Question #33 of 75 Question ID: 1474228 Sharon Pope has been asked by the Chief Investment Officer to develop a firm-wide policy for proxy voting. Which of the following would NOT be acceptable to include in the policy statement? A) Portfolio managers of active funds must vote in all proxies; portfolio managers of index funds should vote only when they have a definitive opinion. B) Voting proxies may not be necessary in all instances. C) The value of proxy voting must be maximized. Explanation Proxies for stocks in passively managed funds must also be voted. A cost-benefit analysis may show that voting all proxies may not benefit all clients. (Module 43.4, LOS 43: III(A)) Question #34 of 75 Question ID: 1474226 When a firm seeks to allocate a disproportionate number of shares of a hot IPO to performance-based fee accounts this constitutes a violation of the Standard concerning: A) priority of transactions. B) additional compensation arrangements. C) fiduciary duty. Explanation The allocation of a disproportionate number of shares to performance-based fee accounts constitutes a violation of fiduciary duty, in addition to being a violation of the Standard concerning fair dealing. (Module 43.4, LOS 43: III(A)) Question #35 of 75 Question ID: 1474272 A money management firm has created a new junk-bond fund. When the firm advertised the new fund at its issuance, they used care to accurately compute the returns from the past 10 years for all assets in the fund. The firm used the current portfolio weights to determine an average annual historical return equal to 18% and claim an 18% annual historical return in their advertising literature. With respect to Standard III(D), Performance Presentation, this is: A) in compliance. B) a violation because the Standard prohibits computing historical returns on risky assets like junk bonds. C) a violation because the advertisement implies the firm generated this return. Explanation Reporting the historical returns of all assets now in the fund introduces a survivorship bias. Also, the advertisement is misleading because the fund just came into existence and has no historical record. Thus, the firm has misled the public as to their performance history. (Module 43.6, LOS 43: III(D)) Question #36 of 75 Question ID: 1474237 The following information pertains to the Galaxy Trust, a trust established by Stephen P. House and managed by Gamma Investment LLC: At the time the trust was established House provided $5 million in cash to fund the trust, but Gamma was aware that 93% of his personal assets were in the form of Oracle stock. Gamma has been asked to view his funds and the trust as a single entity for planning purposes, since House's will stipulates that all of his estate will pass to the trust upon his death. The investment policy statement, developed in September 1996, stipulates that the trust should maintain a short position in Oracle stock and use the proceeds to diversify the trust more adequately. House was able to sell all of his Oracle shares back to the corporation in January 1999 for cash. The policy statement redrawn in September 1999 continues to stipulate that the trust hold a short position in Oracle stock. House has given the portfolio manager in charge of the trust an all-expenses paid vacation package anywhere in the world each year at Christmas. The portfolio manager has reported this fact in writing to his immediate supervisor at Gamma. Which of the following is most correct? The investment manager is: in violation of the Code and Standards by not properly updating the investment A) policy statement in light of the change in the circumstances and is in violation with regard to the acceptance of the gift from House. not in violation of the Code and Standards for not properly updating the B) investment policy statement in light of the change in the circumstances and is not in violation with regard to the acceptance of the gift from House. in violation of the Code and Standards by not properly updating the investment C) policy statement in light of the change in the circumstances but is not in violation with regard to the acceptance of the gift from House. Explanation The investment manager is in violation of the Standard requiring him to make a reasonable inquiry into the client's financial situation and update the investment policy statement since such a dramatic change in the client's circumstances would undoubtedly alter the investment policy statement and would probably eliminate the need to hold a short position in Oracle. The investment manager is not in violation of the Standard concerning additional compensation, since the gift has been reported to his supervisor and has come from a client. If there was a failure to report such a gift, if the firm had a rule in place against the acceptance of gifts from clients, or if the gift had come from a non-client, there would be a violation of the standard. (Module 43.5, LOS 43.b) Question #37 of 75 Question ID: 1474270 Paul Salyer, a portfolio manager, is making a presentation to a prospective client. Paul says that as a new portfolio manager, he made an average annual rate of return of 50% in the last two years at his previous firm and that based on this, he can guarantee a 50% return to the client. Which of the following statements is in accordance with Standard III(D), Performance Presentation? A) Stating his past performance as long as it is fact. B) Imputing his past performance to future performance. C) Implying that he can guarantee a return. Explanation There is no evidence that he's lying about his past performance. He is in violation for implying that he can guarantee performance, for using short-term performance, and for imputing the manager's past performance to future performance. (Module 43.6, LOS 43: III(D)) Question #38 of 75 Question ID: 1474208 June Bird is a pension consultant asked to advise on the Backwater County Pension Plan. Bird notices that 20 percent of the plan's assets are invested in privately held local businesses. Bird is concerned about the lack of liquidity and diversification caused by such an investment. She learns that state law allows investing in local businesses and county law requires at least one-fifth of the plan's assets to be dedicated to investing in local businesses. Bird: A) should recommend that the trustees resign or risk being sued for violating the Prudent Expert Rule. B) can continue to advise the pension plan as best she can with the restrictions. C) should file a written complaint to the Department of Labor pointing out that the law is in conflict with the Employee Retirement Income Security Act (ERISA). Explanation According to Standard III(A), Loyalty, Prudence, and Care, Bird can continue to serve as a consultant to the plan, but must follow the applicable law. (Module 43.4, LOS 43.a) Question #39 of 75 Question ID: 1474240 Which of the following would be a violation of Standard III(B), Fair Dealing? A) Limiting the number of employees privy to recommendations and changes. B) Having well defined guidelines for pre-dissemination. C) Trading for regular accounts before discretionary accounts. Explanation Do not discriminate against a client when disseminating investment recommendations. If the firm offers different levels of service, this fact must be offered and disclosed to all clients. The other choices are necessary parts of the Standard. The Standard actually says to have published personal guidelines for pre-dissemination, which implies that the guidelines be well-defined. (Module 43.5, LOS 43: III(B)) Question #40 of 75 Question ID: 1474214 Paul Drake is employed by a company to provide investment advice to participants in the firm's 401(k) plan. Company stock is one of the investment options in the plan. Drake feels that the stock is too risky for employees to own in their 401(k) plan and starts advising them to pull out of the stock. The Treasurer of the company calls Drake and tells him that he will be fired if he continues making such advice because he is violating his fiduciary duty to the company. Drake should: A) continue to advise employees to sell their stock. B) C) make sell recommendations but point out that the company Treasurer has a differing and valid point of view. tell employees that he cannot provide advice on company stock because of a conflict of interest. Explanation Although Drake is paid by the company, his fiduciary duty is to the plan participants. His advice cannot be compromised by business considerations, otherwise he will be violating the Standard on loyalty, prudence, and care. (Module 43.4, LOS 43.b) Question #41 of 75 Question ID: 1474271 Nancy Korthauer, CFA, has launched a new hedge fund called the Korthauer Tautology Fund and is actively soliciting clients from competitor's firms. Client presentations are necessarily brief and often take place with the prospective client's current investment advisor in the room. The Code and Standards require that: A) a prospective client’s current investment advisor not participate in meetings. B) C) member or candidate provide (on request) additional detail information which supports the abbreviated presentation. all client presentations provide a thorough review of all elements of the investment management process. Abbreviated presentations are forbidden. Explanation See Standard III(D). When presentations are brief, additional detail which supports the abbreviated presentation information must be provided on request. Best practice dictates that the member or candidate should make reference to the abbreviated nature of the presentation. (Module 43.6, LOS 43: III(D)) Question #42 of 75 Question ID: 1474235 Scott Andrews, CFA, is a stockbroker selling an oversubscribed stock issue. Which of the following best describes Andrews' actions regarding this sale? Andrews: A) B) can only offer this security to clients for which it is appropriate on a first come first serve basis. can offer this security on a prorated basis to all clients for which the security is appropriate. C) cannot offer an oversubscribed issue of stock to any clients. Explanation Standard III(B), Fair Dealing, applies. When new issues or secondary offerings are available or are being offered by the firm or if the firm is part of a selling syndicate, all clients for whom the security is appropriate are to be offered a chance to take part in the issue. If the issue is oversubscribed, then the issue is to be prorated to all subscribers. (Module 43.5, LOS 43.b) Question #43 of 75 Question ID: 1474217 Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades for the fund with River City Brokerage. River City provides Calaveccio with soft dollars to purchase research. River City also deals in municipal bonds, some of which Calaveccio holds in his personal portfolio. He periodically uses the soft dollars to request research reports on various small cap stocks and also on the status of the municipal bond market and issues that he holds. These actions are: A) in violation of his fiduciary duties regarding the municipal bond research but not so regarding the research on the small cap issues. B) not in violation of the Code and Standards. C) in violation of his fiduciary duties regarding both the small cap research and the municipal bond research. Explanation The issue at hand is the member's fiduciary responsibilities in handling "soft dollars" which are technically the property of the client. Standard III(A), Loyalty, Prudence, and Care, delineates the member's fiduciary responsibilities with regard to soft dollars. Since municipal bond research is clearly not relevant to the Small Cap Fund holders, he is clearly using the soft dollars to obtain research for his personal benefit and is in violation of the Standard. (Module 43.4, LOS 43: III(A)) Question #44 of 75 Question ID: 1474250 Which of the following statements regarding allocating trades is CORRECT? It is permissible under the Standards to allocate trades: A) based upon any method the firm deems suitable so long as the allocation procedure has been disclosed to all clients. B) based upon compensation arrangements. C) on a pro-rata basis over all suitable accounts. Explanation It is permissible to allocate trades on a pro-rata basis over all suitable accounts. It is not permissible to base allocations upon compensation arrangements. Any method is not necessarily suitable, and disclosure does not absolve the member from ensuring that the allocation is necessarily fair. (Module 43.5, LOS 43: III(B)) Question #45 of 75 Question ID: 1474223 Alan Cramer, CFA, practices in a country that does not regulate the investment of company retirement plans. He was retained by Bingham Companies to manage their corporate pension plan. Bingham's management has approached Cramer and requested that Cramer invest the entire plan in Bingham stock. Cramer may: A) B) not invest any of Bingham Company's retirement plan in its own stock regardless of the stock's prospects and in spite of management's request. invest a portion of the retirement plan in Bingham Company stock if the investment is prudent and if he keeps the overall portfolio properly diversified. invest all of the retirement plan assets in Bingham Company stock according to C) management's request only if Cramer can document that the investment is more prudent than any other investment opportunity he finds. Explanation Standard III(A), Loyalty, Prudence, and Care, requires members to comply with their fiduciary duty. Retirement plan managers owe their duty to the plan participants, not to the management of the company sponsoring the plan. The fiduciary duty includes the obligation to diversify the plan's investments, regardless of the quality of the sponsoring company's stock. Investing in the company's stock is not prohibited. (Module 43.4, LOS 43: III(A)) Question #46 of 75 Question ID: 1474245 Instagram:- @laxmicopycenter Rey Sanchez, CFA, covers the specialty chemical industry for Rock Advisory Associates. Until today he has had a buy recommendation on ChemStar, and many of the firm's customers have purchased shares based upon his recommendation. The firm's client accounts are divided into two fundamental categories: trading and buy-and-hold accounts. The firm holds discretionary trading authority over the trading accounts, but not the buy-and-hold accounts. Sanchez has recently come to believe that the fundamentals are changing for the worse at ChemStar, and is preparing a sell recommendation. He calls a meeting of the firm's portfolio managers with accounts holding ChemStar and tells them of the pending release of the sell recommendation. On this basis, the portfolio managers sell all positions in the discretionary accounts but not in the buy-and-hold accounts. Sanchez completes and mails the report to all clients two days later, and, shortly thereafter, many of the buy-and-hold accounts sell their ChemStar positions. With regard to these actions, Sanchez is: A) B) C) not in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing. in violation of the Standard on Fair Dealing; the portfolio managers are not in violation of the Standard on Fair Dealing. in violation of the Standard on Fair Dealing; the portfolio managers are in violation of the Standard on Fair Dealing. Explanation Sanchez is in violation of the Standard III(B), Fair Dealing, since he has disseminated his recommendation preferentially to the portfolio managers in advance of making the report available to all clients who hold shares of ChemStar. The portfolio managers are in violation of the Standard since they are effectively giving preferential treatment to the trading accounts over the buy-and-hold accounts in the placement of orders based upon the change in recommendation. (Module 43.5, LOS 43: III(B)) Question #47 of 75 Question ID: 1474227 Mohawk Asset Management buys on-the-run Treasuries at auction for its standard fee accounts. When these move off-the-run, they are placed in performance-based accounts via in-house cross-trades at prevailing market prices, and replaced in the standard fee accounts with new on-the-run issues. Which standard is violated, if any? A) The Standard concerning Priority of Transactions. B) No Standard is violated. C) The Standard concerning Fiduciary Duty. Explanation In addition to being a violation of the Standard concerning Fair Dealing, this constitutes a violation of Mohawk's Fiduciary Duty. Why? Because the on-the-run issues are benchmarks and trade at lower yields than the off-the-run issues. In essence, the off-the-run issues have marginally higher returns, and this will boost the returns in the performance-based fee accounts. Mohawk is allocating trades based upon compensation arrangements, and this is not permissible under the Code and Standards. (Module 43.4, LOS 43: III(A)) Question #48 of 75 Question ID: 1474277 Standard III(E), Preservation of Confidentiality, applies to the information that an analyst learns from: A) current clients and prospects only. B) current clients, former clients, and prospects. C) current clients and former clients only. Explanation According to Standard III(E), Preservation of Confidentiality, an analyst must preserve the confidentiality of information communicated by clients, former clients, and prospects. (Module 43.6, LOS 43: III(E)) Question #49 of 75 Question ID: 1474210 Jordan Conomos is the new trustee for the Grant Trust, which has both current beneficiaries and remaindermen. Up until now, the trust has been entirely invested in long-term tax-free municipal bonds. Conomos decides to put 30 percent of the assets in common stocks, with the justification that taxes should be the concern of the trust beneficiaries and not the trust, and the trust needs some diversification and growth. Conomos is: A) violating his fiduciary duty by not considering taxes. B) not violating his fiduciary duty. C) violating his fiduciary duty by not investing solely for the purposes of the current beneficiaries. Explanation The trustee must consider tax liabilities of beneficiaries. However, he should also provide diversification and be concerned with the desires of the remaindermen. (Remaindermen refers to the group that is to receive the remainder of the trust once its term is complete. Of course, some trusts never expire so not every trust has remaindermen.) (Module 43.4, LOS 43.a) Question #50 of 75 Question ID: 1474248 Concerning Standard III(B), Fair Dealing, which of the following statements is CORRECT? The Standard: A) B) C) concerns the dissemination of investment recommendations and the taking of investment action. concerns the dissemination of investment recommendations but is not concerned with the taking of investment action. is not concerned with the dissemination of investment recommendations so long as the taking of investment action is inherently fair. Explanation Standard III(B), Fair Dealing is concerned with both the dissemination of investment recommendations and with the taking of investment action. It follows that this concern is irrespective of whether or not there has been a prior recommendation on the securities in question. (Module 43.5, LOS 43: III(B)) Question #51 of 75 Question ID: 1474254 Which of the following trade allocation procedures is improper? Allocation: A) based upon a predetermined formula. B) based upon past participation in IPOs. C) on a strict pro rata basis over all suitable accounts. Explanation Participation in prior IPOs does not insure suitability for subsequent IPOs. Moreover, this method of allocation could result in a fairness problem, since larger accounts are more likely to have had a greater level of participation in past IPOs. (Module 43.5, LOS 43: III(B)) Question #52 of 75 Question ID: 1474229 Which of the following would be the least important proxy issue? A) Election of internal auditors. B) Compensation plans for officers. C) Takeover defense and related actions. Explanation Election of internal auditors is not a major proxy issue. (Module 43.4, LOS 43: III(A)) Question #53 of 75 Question ID: 1474267 Wanda Brunner, CFA, is reviewing a draft fund prospectus for her new "Leveraged Long Coffee" (LLC), a closed-end fund. LLC uses a of combination fundamental and technical trading models to evaluate individual securities. She notes the LLC prospectus has several disclosures which cause her to worry that prospective clients will avoid her fund. Disclosure 1: "LLC charges a flat 3.00% of assets under management." Disclosure 2: "LLC may invest up to 40% of the fund's assets in securities which are not related to coffee or other consumer products." Disclosure 3: "LLC relies only on fundamental valuation of individual securities." Which of the following standards will most likely be violated by distribution of the prospectus? A) B) Standard III(C) Duties to Clients: Suitability because it misleads the reader as to the process by which securities are selected. Standard III(C) Duties to Clients: Suitability because the fund can hold an excessive portion of the portfolio in non-core assets. C) Standard III(C) Duties to Clients: Suitability because the fees are exorbitant. Explanation LLC must adequately disclose the basic security selection and portfolio construction process, and the portfolio manager recommendations and investment actions must be consistent with the stated objectives and constraints of the fund. By failing to acknowledge the fund's dependence on technical trading, the fund fails to meet this standard. (Module 43.5, LOS 43: III(C)) Question #54 of 75 Question ID: 1474219 Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. Calaveccio places a trade with Quantco Brokerage. While Calaveccio's part of the transaction was conveyed correctly to Quantco, there was a trading error made in Calaveccio's account due to a slip up within Quantco. Calaveccio realizes that the error has taken place, and informs his contact at Quantco. Calaveccio allows Quantco to cover the error, with no cost to TrustCo. This is: A) a violation of Calaveccio's fiduciary duties. B) a violation of Calaveccio's duty to his employer. C) permissible under CFA Institute Standards. Explanation The issue is similar to an allocation of soft dollars. Clearly, if the broker absorbs the loss, they expect to make up the difference in some way. However, since the error was on the part of Quantco Brokerage, Calaveccio is under no obligation to cover the cost of the trading error. Moreover, no reasonable observer expects that there exists any implied future allocation of trades to Quantco in return for correcting their own mistake. There is no violation of Standard III(A), Loyalty, Prudence, and Care. (Module 43.4, LOS 43: III(A)) Question #55 of 75 Question ID: 1474206 Which of the following statements about a member's use of client brokerage commissions is NOT correct? Client brokerage commissions: A) should be commensurate with the value of the brokerage and research services received. B) may be directed to pay for the investment manager's operating expenses. C) should be used by the member to ensure that fairness to the client is maintained. Explanation Brokerage commissions are the property of the client and may only be used for client benefit. (Module 43.4, LOS 43.a) Question #56 of 75 Question ID: 1474281 Albert Long, CFA, manages portfolios of high net worth individuals for HKB Corp. Alice Thurmont, one of his close friends, heads a local charity for homeless children that depends on donations to operate. Because donations have declined during the past year, the charity is experiencing financial difficulty. Thurmont asks Long to give her a partial list of his clients so that she can contact them to make tax-deductible donations. Because Long knows that the charity provides much benefit to the community, he provides Thurmont with the requested list. Betty Short, CFA, also works for HKB Corp. She receives a letter from CFA Institute's Professional Conduct Program (PCP) requesting that she provide information about one of HKB's clients who is being investigated. Short complies with the request despite the confidential nature of the information requested by the PCP. Based on Standard III(E), Preservation of Confidentiality, which of the following statements about Long and Short's actions is CORRECT? A) Long violated Standard III(E) but Short did not violate Standard III(E). B) Both Long and Short violated Standard III(E). C) Short violated Standard III(E) but Long did not violate Standard III(E). Explanation Long violated Standard III(E) because he did not preserve the confidentiality of information communicated by clients. Short did not violate Standard III(E) because this standard does not prevent members from cooperating with an investigation by CFA Institute's Professional Conduct Program. Thus, Short can forward confidential information to the PCP. (Module 43.6, LOS 43: III(E)) Question #57 of 75 Question ID: 1474224 A member would most likely violate the Standard regarding duties to clients by: A) B) C) adding a risky derivative security to the portfolio of a client with moderate risk tolerance. recommending purchase of securities without a reasonable inquiry into the investment experience of the client. executing a client order for a security the member believes is greatly overvalued. Explanation Standard III(A) Loyalty, Prudence, and Care requires members acting as advisors to make a reasonable inquiry into the client's investment experience, risk and return objectives, and financial constraints before making investment recommendations. Investment decisions must be made based on a total portfolio approach, rather than the quality of an individual investment in isolation. Some members are not acting as investment advisors and may only have a duty to provide best execution of client orders. (Module 43.4, LOS 43: III(A)) Chandra Patel, CFA, manages private client portfolios for QED Investment Advisers. Part of QED's firm-wide policy is to adhere to CFA Institute Standards of Professional Conduct in the management of all client portfolios, and to this end, the firm requires that client objectives, investment experience, and financial limitations be clearly established at the outset of the relationship. This information is updated at regular intervals not to exceed eighteen months. The information is maintained in a written investment policy statement (IPS) for each client. Anarudh Singh has been one of Patel's clients ever since she began managing money ten years ago. Shortly after his regular situational update, Singh calls to inform Patel that his uncle is ill, and it is not known how long he will survive. Singh expects to inherit "a sizeable sum of money," mainly in the form of municipal bonds. His existing portfolio allocation guidelines are for 75% to be invested in bonds. Singh believes that the expected inheritance will allow him to assume a more aggressive investment profile and asks Patel to begin moving toward a 75% allocation to equities. He is specifically interested in opening sizable positions in several technology firms, some of which have only recently become publicly traded companies. Patel agrees to begin making the changes to the portfolio and the next day begins selling bonds from the portfolio and purchasing stocks in the technology sector as well as in other sectors. After placing the trade orders, Patel sends Singh an email to request that he come to her office sometime during the next week to update his IPS. Singh replies to Patel, saying that he can meet with her next Friday. A few days before the meeting, however, Singh's uncle dies and the portfolio of municipal bonds is transferred to Singh's account with QED. Patel sees this as an opportunity to purchase more technology stocks for the portfolio and suggests taking such action during her meeting with Singh, who agrees. Patel reviews her files on technology companies and locates a report on NetWin. The analyst's recommendation is that this stock is a "core holding" in the technology sector. Patel decides to purchase the stock for Singh's account in addition to several other wealthy client accounts with high risk tolerance levels, but due to time constraints she does not review the holdings in each account. Patel does examine the aggregate holdings of the accounts to determine the approximate weight that NetWin should represent in each portfolio. Since Patel has very recently passed the Level III examination, QED sends a promotional email to all of the firm's clients. The email states that "QED is proud to announce that Chandra Patel is now a CFA (Chartered Financial Analyst). This distinction, which is the culmination of many years of work and study, is further evidence of the superior performance you've come to expect at QED." Patel also places phone calls to several brokers that she uses to place trades for her accounts, stating that she "passed all three CFA examinations on the first attempt." One of the people Patel contacts is Max Spellman, a long-time friend and broker with TradeRight Brokers Inc. Patel uses the opportunity to discuss her exclusive trading agreement with TradeRight for Singh's account. When ordering trades for Singh's account, Patel's agreement with TradeRight for brokerage services requires her to first offer the trade to TradeRight, and then to another broker if TradeRight declines to take the trade. TradeRight never refuses the trades from any manager's clients. Patel established the relationship with TradeRight because Singh, knowing the firm's fee schedule relative to other brokers, asked her to do so. However, because TradeRight is very expensive and offers only moderate quality of execution, Patel is considering directing trades on Singh's account to BullBroker, which charges lower commissions and generally completes trades sooner than TradeRight. Question #58 - 63 of 75 Question ID: 1474261 Do QED's policies comply with CFA Institute Standards of Professional Conduct with respect to the information contained within the client IPS' and the frequency with which the information is updated? Information Frequecy A) No No B) No Yes C) Yes No Explanation According to Standard III(C)—Suitability, members and candidates must consider investment experience, objectives (risk and return), and constraints before investing funds on the client's behalf or recommending investments to the client. The firm has complied with the information content. The investment policy statement must be updated at least annually, or after significant changes in client circumstances, however, according to the guidance statement accompanying Standard III(C). Thus, the firm has not complied with Standard III(C) in this regard. (Module 43.5, LOS 43: III(C)) Question #59 - 63 of 75 Question ID: 1474262 In light of Singh's comments during his telephone call to Patel prior to his uncle's death, which of the following actions that Patel can take comply with CFA Institute Standards of Professional Conduct? A) Patel may change the current portfolio strategy and begin trading based upon Singh’s expectations because he advised her to do so. Patel must adhere to the existing portfolio strategy until she meets with Singh B) to develop a new portfolio strategy based upon updated financial information, but may place trades which are consistent with the existing strategy. C) Patel must not place any trades in the account until she meets with Singh to develop a new portfolio strategy based on the updated information. Explanation According to Standard III(C)—Suitability, Patel must observe the written investment objectives now in effect as determined in cooperation with the client and may trade only on that basis. Because the anticipated change in Singh's financial condition was subject to an event of indeterminable timing, she should continue to honor the existing written investment objectives until a change is warranted by an actual increase in the client's total financial assets and has been agreed upon with her client. (Module 43.5, LOS 43: III(C)) Question #60 - 63 of 75 Question ID: 1474263 According to CFA Institute Standards of Professional Conduct, may Patel reallocate Singh's portfolio toward technology stocks after his Uncle dies, but before the meeting with Singh? A) No—Patel and Singh must meet and revise the IPS and portfolio strategy before reallocating. B) No—Patel must wait until the next annual meeting to reallocate. C) Yes—the total value of the municipal bonds received into the account will be too large relative to the other assets in the portfolio. Explanation According to Standard III(C)—Suitability, investment recommendations and actions must be consistent with a client's written objectives and constraints (typically in the form of an IPS). Because Singh's written IPS would not allow the large allocation to technology stocks prior to receiving the inheritance, the IPS must be updated by Singh and Patel prior to taking any actions that deviate from the original IPS. Patel will violate Standard III(C) by reallocating the portfolio before meeting with Singh. (Module 43.5, LOS 43: III(C)) Question #61 - 63 of 75 Question ID: 1474264 Did Patel violate any CFA Institute Standards of Professional Conduct when she purchased the NetWin stock for Singh's portfolio or for the other clients' portfolios? Singh's Other portfolios portfolio A) No Yes B) Yes Yes C) No No Explanation According to Standard III(C)—Suitability, Patel must analyze the appropriateness and suitability of NetWin.com stock on a case-by-case basis before buying it. This will necessarily consider the basic characteristics of the security and how these will affect overall portfolio characteristics relative to the existing investment strategy for each portfolio. Patel has not analyzed the effect that the stock will have on any of the individual portfolios in question and has thus violated the Standard. Patel cannot look at aggregate measures to determine the appropriate weight that the security should represent in the individual portfolios because the portfolios are being managed individually, not in aggregate. (Module 43.5, LOS 43: III(C)) Question #62 - 63 of 75 Question ID: 1474265 Which of the following is least accurate regarding the promotional announcement of Patel passing the Level III exam? A) B) C) The announcement violates the Code of Ethics because it implies that obtaining a CFA charter leads to superior performance. The promotional announcement assumes that passing of the Level III examination of the CFA program allows one to use the CFA designation. The promotional announcement violates the restrictions on misrepresenting the meaning of the CFA designation. Explanation An announcement that a member of a firm has received the right to use the CFA® designation is not a violation of the Code or Standards. However, Standard VII(B) requires that any reference to the charter must not misrepresent or exaggerate the meaning or implications of the CFA designation. A charterholder cannot claim that holding a charter leads to superior performance results. The letters "CFA" can only be used as an adjective (never a noun, as in "he is a CFA"). Finally, passing all three exams does not give one the right to use the designation. All criteria must be met (e.g., experience requirements) before Patel can use the designation. (Module 43.5, LOS 43: III(C)) Question #63 - 63 of 75 Question ID: 1474266 With respect to the choice of broker, did Patel violate any CFA Institute Standards of Professional Conduct? A) B) Yes, since Patel failed to properly notify Singh that using TradeRight would lead to higher commissions and opportunity costs. Yes, since Patel is obligated to seek the best possible price and execution for all clients. C) No. Explanation Since Singh directed Patel to use TradeRight, this should be considered client-directed brokerage. While Patel should inform Singh of the implications of that choice, Patel has no option but to follow the client's direction according to Standard III(A)—Loyalty, Prudence, and Care. Singh was fully aware of the fees charged by TradeRight relative to other brokerage firms, but elected to use them anyway. Investment managers are obligated to seek the best price and execution in the absence of client direction. (Module 43.5, LOS 43: III(C)) Question #64 of 75 Question ID: 1474241 An analyst meets with a new client. During the meeting, the analyst sees that the new client's portfolio is heavily invested in one over-the-counter stock. The analyst has been following the stock and thinks it will perform well in the long run. The analyst arranges through a brokerage firm to simultaneously sell a large number of shares of the stock via a series of cross trades from the new client's portfolio to various existing clients. He arranges the trades to be executed at a price that approximates the current market price. This action is: A) a violation of Standard III(A), Loyalty, Prudence, and Care. B) not in violation of the Standards. C) a violation of Standard III(B), Fair Dealing. Explanation There is no violation. It is in the best interest of the client to be diversified and selling via a series of cross trades will likely reduce price impact costs when compared to selling directly into the market. The analyst appears to have reasonable basis for putting the securities in the accounts of other clients. (Module 43.5, LOS 43: III(B)) Question #65 of 75 Question ID: 1474251 Which of the following statements regarding allocating trades is CORRECT? It is: permissible under the standards to allocate trades on the basis of a A) predetermined formula that may deviate from a pro rata basis but is inherently fair. B) never permissible to deviate from a pro rata basis, unless this is done on the basis of an advance indication of interest in the issue. never permissible to deviate from a proportional account value weighting C) method of trade allocation, unless this is done on the basis of an advance indication of interest in the issue. Explanation If the firm has developed an allocation procedure that is formula-based, inherently fair, and the details are disclosed to clients, it is possible to deviate from a pro rata allocation basis. (Module 43.5, LOS 43: III(B)) Question #66 of 75 Question ID: 1474257 An analyst thinks that a major change in the tax law will benefit holders of utility company stocks. She immediately begins calling all her clients and telling them of the upside potential of investing in such assets now. Based upon this information, this is most likely: A) a violation of Standard III(C), Suitability. B) congruent with Standard V(A), Diligence and Reasonable Basis. C) a violation of Standard V(A), Diligence and Reasonable Basis. Explanation According to Standard III(C), the analyst needs to determine the suitability of an investment for each client. It is doubtful that all her clients are identical in their needs. According to the information, the analyst mentions the upside potential but does not mention the downside risk. Although the information says that she thinks that the change in the tax law will benefit holders of utility company stocks and says nothing of how she arrived at this conclusion, we do not know if she has or has not made her decision on a reasonable basis. (Module 43.5, LOS 43: III(C)) Question #67 of 75 Question ID: 1474216 Member compliance on issues relating to corporate governance or to soft dollars is primarily addressed by the Standard concerning: A) Disclosure of Conflicts to Clients and Prospects. B) Loyalty, Prudence, and Care. C) Disclosure of Referral Fees. Explanation Fiduciary duty on issues relating to corporate governance or to soft dollars is primarily addressed by Standard III(A), Loyalty, Prudence, and Care. (Module 43.4, LOS 43.b) Question #68 of 75 Question ID: 1474244 In securing the shares for all accounts under her management, Linda Kammel of Northwest Futures purchased three blocks of shares at three different prices. She then allocated these shares by placing shares from the first block in accounts with surnames beginning with A-G. The second was allocated over accounts H-P, and the third over Q-Z. This action is: A) permissible only if the clients are informed of the allocation procedure. B) not permissible under the Code and Standards. C) consistent with her responsibilities under the Code and Standards. Explanation Standard III(B) requires a member to deal fairly with all clients when taking investment actions. Since she knew at the outset that she was going to place shares in all accounts, regardless of the first letter of the surname, all accounts must participate on a pro-rata basis in each block in order to conform to the Standard. Her actions constitute a violation of the Standard concerning fair dealing. (Module 43.5, LOS 43: III(B)) Question #69 of 75 Question ID: 1474213 Brenda Simone is a money manager and the Blue Streets Pension Fund is one of her clients. The director of the pension fund calls Simone and asks her to use a particular broker so that the fund can obtain some research services with the soft dollars from that broker. Simone believes that the desired broker will provide the same price and execution as the normal broker that Simone uses. Simone does as the client wishes. Simone has: A) B) not violated the Standards as long as the research provided by the broker will benefit Blue Streets. not violated the Standards as long as the research provided by the broker will benefit the plan beneficiaries. C) violated the Standards. Explanation Simone must ensure that the research benefits the parties to whom she owes fiduciary duty, which are the plan participants. (Module 43.4, LOS 43.b) Question #70 of 75 Question ID: 1474280 One year ago, Karen Jason left the employment as a portfolio manager of Howe Advisors. The departure was contentious and both parties threatened legal action. As a result, both parties signed a settlement in which Jason was paid a prorated bonus, but agreed not to work on the portfolios of any existing Howe client for two years. The terms of the agreement were that both parties agreed to keep all aspects of the agreement confidential, including the fact that there was hostility surrounding the departure. Jason now works for Torre Advisors, who has the Stein Company as a new client. At the time Jason left Howe, Stein was a client of Howe, although Jason did not personally work on the Stein portfolio. Jason's supervisor at Torre wants Jason to work on the Stein portfolio. Jason should: A) B) C) inform her supervisor that she cannot work on the portfolio because of a noncompete agreement. inform her supervisor that she cannot work on the portfolio because of a legal agreement, but cannot tell him why. work on the portfolio because she did not personally work on the portfolio when she was at Howe. Explanation Jason must inform her supervisor of the conflict, but she cannot violate the terms of the confidentiality agreement and she cannot work on the portfolio. (Module 43.6, LOS 43: III(E)) Question #71 of 75 Question ID: 1474253 Concerning Standard III(B), Fair Dealing, which of the following actions is NOT a valid procedure for compliance with the Standard? A) B) C) Communicate investment recommendations simultaneously within the firm and to customers, where possible. Limit the number of people that are involved and are privy to the fact that an investment recommendation is going to be disseminated. Communicate investment recommendations to all customers including those accounts for which the securities are not eligible for purchase. Explanation To ensure compliance with the Standard, members should seek to communicate investment recommendations to all clients who have indicated an interest and also those for whom the securities are suitable. There is no need to communicate recommendations to clients for whom the securities are deemed unsuitable. (Module 43.5, LOS 43: III(B)) Question #72 of 75 Question ID: 1474247 Alba Vasquez allocates trades of hot new IPOs as follows: m×p/(p+s) shares to performancebased fee accounts, m×s/(p+s) shares to standard fee accounts, where there are p suitable performance based fee accounts, s suitable standard fee accounts, and m shares available. This action is: A) not permissible since it is based upon a formula that is not inherently fair. B) permissible since it effectively amounts to a strict pro rata basis of allocation. C) not permissible since it effectively favors the performance-based fee accounts. Explanation The formula shown above is nothing more than a simple pro rata basis of allocation (assuming that the shares are then subsequently allocated in the same fashion over all of the sub accounts by category). Hence, this is permissible. (Module 43.5, LOS 43: III(B)) Question #73 of 75 Question ID: 1474221 According to Standard III(A) Loyalty, Prudence and Care, brokerage is an asset of the: A) brokerage firm conducting the trades. B) client. C) managing firm. Explanation Brokerage is an asset of the client. (Module 43.4, LOS 43: III(A)) Question #74 of 75 Question ID: 1474269 Ned Brenan manages two dozen pension accounts, one of which earned over 25% during the past two years. Brenan tells prospective clients that based on past experience they can expect a 25% return on their funds. Which of the following statements is CORRECT? A) B) C) Brenan has not violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has violated Standard I(C), Misrepresentation. Brenan has violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has not violated Standard I(C), Misrepresentation. Brenan has violated both Standard of Professional Conduct III(D), Performance Presentation, and Standard I(C), Misrepresentation. Explanation Brenan violated Standard of Professional Conduct III(D) by using only one portfolio's results to create a false impression of all the portfolios, and Brenan violated Standard of Professional Conduct I(C) by creating the impression that a certain return was assured (he should have used the words "might" or "could" instead of "can"). (Module 43.6, LOS 43.b) Question #75 of 75 Question ID: 1474220 Regarding (1) not voting all client proxies, and (2) using a directed brokerage arrangement, a member would violate the Standards by: A) using a directed brokerage arrangement. B) not voting all proxies for client stocks. C) engaging in neither of these practices. Explanation Proxies have economic value to the client. To comply with Standard III(A) Loyalty, Prudence, and Care, the analyst is obligated to vote proxies in an informed and responsible manner. A cost benefit analysis may show that voting all proxies may not benefit the client, so voting proxies may not be necessary in all instances. Directed brokerage occurs when the client requests that a portion of the client's brokerage be used to purchase services that directly benefit the client. Although this may prevent best execution, it does not violate the Standards as it was directed by the client, not the brokerage firm. (Module 43.4, LOS 43: III(A))