Answers - Reading 43.6 Standards VI of Professional Conduct Guidance

Hunter Harrison, CFA, has recently been promoted to Chief Investment Officer (CIO) of Ironclad Investments, an investment adviser and pension consultant for medium and large corporate pension clients. Ironclad recently hired a compliance officer to update its compliance manual, which is consistent with the CFA Institute Code and Standards. Harrison serves as a director on several non-profit and corporate boards of directors, some of which have their pension assets managed by Ironclad. As part of his new job duties, Harrison will oversee Ironclad's research analysts and portfolio managers, including Michelle Myers, who passed the Level II CFA examination last year and is registered for the next exam. Myers is a portfolio manager who regularly meets with clients and prospects. Myers is also a partner in a software company that sells retirement and benefit administration services to institutional clients, some of which are also clients of Ironclad to whom Myers has recommended the software company. Myers has disclosed her partnership interest in the software company to Ironclad, including the potential for additional compensation and the possible conflicts of interest, but not to her clients. One of Myers' software clients, Breakthrough Pharmaceuticals (Breakthrough), is a publicly traded corporation that is also held in many of Ironclad's client portfolios. In the course of their business relationship, Breakthrough's CEO informs Myers that the company has been having difficulty making retirement benefit payments, and its pension plan has recently gone from "overfunded" to "significantly underfunded" as a result of market conditions. Breakthrough's CEO indicates to Myers that he is attempting to source additional short-term financing to make retiree benefit payments and will disclose the significant "underfunded status" of the pension plan in the upcoming financial statements. Myers, concerned that Breakthrough's current pension troubles and short-term liquidity issues will negatively affect its earnings and consequently the performance of the company's stock, informs Harrison of the impending disclosure. Harrison allows Myers to sell 1,800,000 shares of Breakthrough stock for clients, causing the price to drop by 5%. When the pension troubles are later disclosed in the company's financial statements, Breakthrough's stock price drops an additional 18%. Harrison, as CIO, is chairman of Ironclad's proxy voting committee. Myers is also a member of the committee. Ironclad, as a discretionary investment manager, votes proxies through the proxy voting committee on behalf of clients. Ironclad is currently reviewing proxies for several companies covered in research, including technology companies Advanced DSL (Advanced), InterConnect Inc. (InterConnect), Speedy Chip Technology (Speedy Chip), and Wavelength Digital (Wavelength). Each company's current proxy contains voting proposals pertaining to employee stock option expensing methods. This issue is particularly important to Ironclad because several of its investment personnel recently participated in an industry forum that supported increased disclosure for company stock options. The panel concluded that such disclosure will provide investors with a more complete estimate of corporate earnings. Ironclad, through its clients, owns approximately 4% of the outstanding shares of Advanced and InterConnect and approximately 6% of the outstanding shares of Speedy Chip and Wavelength. Harrison serves on the board of directors for InterConnect and Wavelength, while Myers provides consulting services for Speedy Chip. Harrison receives cash compensation and stock options for his services, while Myers receives restricted stock and stock options. The investment bank that led the public offering of InterConnect and Speedy Chip and seven of nine sell-side analysts covering the companies have "sell" ratings on the stocks. Ironclad's analysts have also issued "sell" recommendations on the companies due to, among other issues, lack of earnings transparency and low earnings quality. Contrary to committee consensus, Harrison and Myers vote client proxies "against" the expensing of employee stock options for InterConnect, Wavelength, and Speedy Chip. Harrison increases his clients' positions in both InterConnect and Wavelength, citing "growth opportunities" and "consensus opinion." Neither Harrison nor Myers has disclosed these compensation arrangements to Ironclad. Question #1 - 4 of 39 Question ID: 1474421 Is it likely that Myers violated any CFA Institute Standards of Professional Conduct with respect to her disclosure of the partnership interest in the software company or did Harrison violate any standards with respect to the sale of Breakthrough stock? Partnership interest Breakthrough sale A) No Yes B) Yes Yes C) Yes No Explanation Standard VI(A) – Disclosure of Conflicts, is applicable since Myers is a portfolio manager with fiduciary responsibility for institutional clients of Ironclad who may also be clients of her software company, thereby potentially compromising her ability to make unbiased and objective investment recommendations. Myers should disclose the potential conflict to her clients and to Ironclad and abide by any restrictions imposed by the firm. Myers has not disclosed the conflict to clients and has therefore violated the Standard. Harrison has violated Standard IV(C) – Responsibilities of Supervisors by failing to prevent Myers from trading on material nonpublic information. He has a responsibility as a supervisor to make reasonable efforts to detect and prevent violations of the Standards by his employees. (Module 43.9, LOS 43.a) Question #2 - 4 of 39 Question ID: 1474422 Is it likely that Myers violated any CFA Institute Standards of Professional Conduct by selling the Breakthrough stock for her clients' accounts? A) Yes, because the information shared by Breakthrough's CEO was nonpublic. B) No, because Myers is not considered an insider with respect to the information. C) No, because Myers has a fiduciary duty to her clients. Explanation Although the information shared by Myers may have helped Ironclad's clients avoid losses in shares of Breakthrough, the information was material nonpublic information. Information is "material" if its disclosure would have an impact on the stock or if a reasonable investor would want to know the information prior to making an investment decision. Information is "nonpublic" until it has been generally disseminated to the marketplace and investors have had an opportunity to react to the information. The information about Breakthrough's pension difficulties was both material and nonpublic, as the stock dropped significantly upon disclosure of the information in the market. Therefore, Myers had a duty to keep the information confidential and not to trade or cause others to trade on the information. By sharing the information with Harrison and trading on that information, Myers violated Standard II(A) – Material Nonpublic Information. (Module 43.3, LOS 43.a) Question #3 - 4 of 39 Question ID: 1474423 With respect to Harrison's directorships with InterConnect and Wavelength and Myers' consulting arrangement with Speedy Chip, is it likely that any CFA Institute Standards of Professional Conduct have been violated? Myers' Harrison's directorships A) Yes Yes B) Yes No C) No No consulting arrangements Explanation Standard IV(B) – Additional Compensation Arrangements, applies to both Harrison and Myers, as they both receive compensation for their respective outside services in the form of cash, stock, and stock options. There is no indication that either of them have disclosed their compensation arrangements to Ironclad, which constitutes a violation of Standard IV(B). Standard I(B) – Independence and Objectivity also applies to this situation, as both Harrison and Myers have outside activities that have the appearance of compromising their independence and objectivity regarding Ironclad's clients. Harrison's role on the boards of directors for InterConnect and Wavelength and Myers' role as a consultant for Speedy Chip appear to drive their proxy voting decisions, on behalf of Ironclad's clients, regarding the expensing of stock options. Thus both Harrison and Myers have also violated Standard I(B). Harrison and Myers may have also violated Statement VI(A) – Disclosure of Conflict by failing to disclose the conflicts of interest that exist as a result of Harrison's directorships with Interconnect and Wavelength and Myers' consulting arrangement with Speedy Chip. Such conflicts (whether actual or potential) are required to be disclosed prominently and in clear language to clients, prospects, and employers according to Standard VI(A). (Module 43.7, LOS 43.a) Question #4 - 4 of 39 Question ID: 1474424 Which of the following least accurately describes Harrison's actions necessary for compliance with the Code and Standards regarding proxy voting? Harrison should: A) B) discard all proxies on behalf of Ironclad’s clients when there is a conflict of interest. abstain from voting on matters affecting Internet and Wavelength to avoid conflicts of interest. C) disclose all proxy voting policies to Ironclad’s clients including the treatment of routine and nonroutine issues. Explanation According to Standard III(A) – Loyalty, Prudence, and Care, Ironclad, as a discretionary investment manager, is responsible (unless otherwise stipulated in the client guidelines or agreement) for making informed and reasonable decisions regarding proxy voting on behalf of clients. Among other things, Ironclad should have a proxy voting policy and a process for identifying and reviewing major proxy issues for appropriate clients. Ironclad and Harrison also have an obligation to avoid conflicts of interest when voting proxies. Although Harrison has a conflict of interest in voting issues on behalf of InterConnect and Wavelength due to his role on their board of directors, proxies on non-routine matters should not be discarded under any circumstances, as such action would constitute a breach of fiduciary duty. Harrison should abstain from voting on matters affecting InterConnect and Wavelength to avoid the appearance of a conflict of interest. Harrison should also ensure proper treatment of any confidential information received in his role on the respective boards of directors. Harrison should maintain confidentiality of voting information on behalf of clients and follow Ironclad's proxy voting policy. Clients must be made aware of the firm's policies on voting routine and non-routine proxy issues. (Module 43.4, LOS 43.a) Question #5 of 39 Question ID: 1474430 Arthur Harrow, CFA, is a pharmaceuticals analyst at Dominion Asset Management. His supervisor directs him to prepare separate research reports on Miracle Drug Company and Wonder Drug Company. Harrow serves on the board of Miracle and owns shares of Wonder. According to the Standards of Professional Conduct, which of the following actions is Harrow required to take when he writes the research reports? A) B) C) Harrow must disclose his ownership of shares in Wonder but not his relationship with Miracle. Harrow must disclose his relationship with Miracle but not his ownership of shares in Wonder. Harrow must disclose both his relationship with Miracle and his ownership of shares in Wonder. Explanation Standard VI(A) Disclosure of Conflicts requires that Harrow disclose matters that reasonably could be expected to interfere with his independence and objectivity. Both Harrow's relationship with Miracle and his ownership of Wonder's shares represent potential conflicts of interest and must be disclosed prominently and in clear language in the research report, giving clients the ability to weigh the possible effects of these potential conflicts on his analysis and conclusions. (Module 43.9, LOS 43: VI(A)) Question #6 of 39 Question ID: 1474444 Standard VI(C), Referral Fees, requires the member to do all of the following EXCEPT: A) B) C) make required disclosures to the referred client before an agreement is made to provide services to the referred client. disclose to the referred client how much the referral source was paid to refer the client. disclose to the referred client the percentage of the member's business that comes from referrals. Explanation The applicable Standard, VI(C), does not require a member to disclose the percentage of their business that comes from referrals. Standard VI(C) states, "Members shall disclose to clients and prospects any consideration or benefit received by the member or delivered to others for the recommendation of any services to the client or prospect." Appropriate disclosure means telling the client or prospect, before agreeing to perform services, of any benefit given or received for recommending the member's services. (Module 43.9, LOS 43: VI(C)) Question #7 of 39 Question ID: 1474431 Lee Hurst, CFA, is an equity research analyst for a long-term investment fund. His annual bonus is linked to quarterly trading profits. Under a new policy, the quarterly assessment period is switched to a monthly assessment period. According to the Code and Standards, best practices dictate: A) updating disclosures when the policy change is implemented. B) requiring Hurst to obtain permission from each client prior to implementation of the new policy. C) keeping the policy change private as a trade secret. Explanation Standard VI(A) "Disclosures of Conflicts" recognizes this policy as a potential conflict of interest as members and candidates could be incentivized to favor short-term trading gains over long-term value creation. Best practices dictate updating disclosures when the policy change is implemented. The long-term investors should know how members and candidates are compensated, especially when there is the potential for conflicts of interest. (Module 43.9, LOS 43: VI(A)) Question #8 of 39 Question ID: 1474443 A firm produces regular proprietary research reports on various companies. According to Standard VI(B), Priority of Transactions, which of the following would be an "access person"? A) A person working in the mail room. B) An independent auditor with access to material, non-public information on a company being analyzed. C) A supervisory analyst who reviews all research reports prior to dissemination. Explanation Persons with access to information during the normal preparation of research recommendations are subject to Standard VI(B). An independent auditor is not involved in the normal preparation of research recommendations. (Module 43.9, LOS 43: VI(B)) Question #9 of 39 Question ID: 1474445 Toni Florence, CFA, CAIA, leases office space to her best friend, Tom Rigs. Florence is an independent investment advisor specializing in high net worth clients and Rigs is a licensed real estate broker. In lieu of paying rent, Rigs refers his real estate clients to Florence, but only with the clients' permission. For clients referred by Rigs, Florence: A) must disclose the terms of the lease arrangement. B) C) need not disclose the referral fee if Rigs discloses the lease arrangement to the clients first. need not disclose the terms of the lease arrangement because Rigs obtained the clients’ permission for the referral. Explanation Standard VI(C), Referral Fees, requires members to disclose to clients and prospects any consideration or benefit received by the member or delivered to others for the recommendation of any services to the client or prospect. Florence has delivered a benefit (free rent) to Rigs, which must be disclosed to the clients referred by Rigs. Florence must not rely on Rigs to make the disclosure. (Module 43.9, LOS 43: VI(C)) Question #10 of 39 Question ID: 1474447 If a CFA charterholder receives a referral fee, he must: A) consult with the firm's compliance officer, and follow his or her instructions concerning disclosure. B) disclose the fee to the supervisor, in written form, as an additional benefit. C) disclose the nature of the fee arrangement to the client before entering into a formal agreement. Explanation According to Standard VI(C), the nature as well as the value of the fee must be disclosed to the client before entering into a formal agreement. The compliance officer and/or the employee's supervisor should be contacted for consultation. (Module 43.9, LOS 43: VI(C)) Question #11 of 39 Question ID: 1474435 Will Lambert, CFA, is a financial analyst for Offshore Investments. He is preparing a purchase recommendation on Burch Corporation for internal use. According to the CFA Institute Standards of Professional Conduct, which of the following statements about disclosure of conflicts is not required? Lambert would NOT need to disclose to his employer that: A) his wife owns 2,000 shares of Burch Corporation. B) he is a beneficiary of a pension plan of his former employer that owns a large number of shares of Burch's stock. C) Offshore is an OTC market maker for Burch Corporation's stock. Explanation Standard VI(A), Disclosure of Conflicts, requires members to disclose to their employer all matters, including beneficial ownership of securities, that reasonably could be expected to interfere with their duty to their employer or ability to make unbiased and objective recommendations. Disclosure of an employer's own involvement with the security is not necessary in this instance. If the report had been for external use, it would have been necessary to make all of the disclosures given as choices. (Module 43.9, LOS 43: VI(A)) Question #12 of 39 Question ID: 1474413 Futura Investments Co. decides to diversify its current portfolio with stocks from three companies in a new segment of the biotechnology industry. William Burgin, CFA, is an analyst at Futura and had previously bought shares of the same three companies for his own portfolio, well before his employer started researching them. Burgin has already disclosed the composition of his personal portfolio to Futura Investments, to be in compliance with the Code & the Standards. Which of the following actions should Burgin take? A) Diversify his personal portfolio so, in this way, these stocks will no longer represent a substantial portion of the portfolio. B) Hire a full discretionary power or blind trust manager for his portfolio. C) Open an account that will be managed by someone else but will allow him to maintain his investment preferences. Explanation Burgin followed Standard VI(A) and informed his employer about the potential conflict of interest. He needs to follow the CFA Institute Standards in the best interest of his employer. To prevent any future problems with conflict of interest, his best option is to discontinue the active management of his personal portfolio and use a blind trust. (Module 43.9, LOS 43.a) Question #13 of 39 Question #13 of 39 Question ID: 1474427 Phil Trobb, CFA, is preparing a purchase recommendation on Aneas Lumber for his research firm. Which of the following least likely represents a conflict of interest that Trobb should disclose in his report? A) Aneas hires Trobb as a consultant to analyze Aneas' financial statements. B) Trobb's cousin repairs machines for Aneas. C) Trobb's research firm has a large stake of ownership in Aneas. Explanation Standard VI(A) Disclosure of Conflicts defines what constitutes a conflict of interest with regard to clients, prospective clients, and employers. All of these represent potential conflicts of interest with the exception of the cousin working for Aneas Lumber in a job that is unrelated to the Aneas' financing. (Module 43.9, LOS 43: VI(A)) Question #14 of 39 Question ID: 1474432 Will Lambert, CFA, is a financial analyst for Offshore Investments. He is preparing a purchase recommendation on Burch Corporation. According to the Standards of Professional Conduct, which of the following relationships with Burch is Lambert least likely required to disclose? A) His son-in-law was formerly employed by Burch. B) His wife owns 2,000 shares of Burch. C) He has a material beneficial ownership of Burch through a family trust. Explanation Standard VI(A) Disclosure of Conflicts requires that Members and Candidates fully disclose all matters which may impair their independence or objectivity or interfere with their duties to their employer, clients and prospects. Beneficial ownership of shares in a firm on which a member is making investment recommendations is an example of such a matter. (Module 43.9, LOS 43: VI(A)) Question #15 of 39 Question ID: 1474446 Wes Smith, CFA, refers many of his clients to Bill Towers, CPA, for accounting services. In return, Towers performs routine services for Smith, such as his tax returns, for no charge. Towers has just become a member of CFA Institute. With this development, Towers must: A) B) reveal to the prospects referred by Smith that he performs services for Smith, along with the estimated value of those services. only reveal to the prospects referred by Smith that he performs services for Smith. C) discontinue his services for Smith. Explanation According to VI(C), Referral Fees, as a member of CFA Institute, Towers must tell his clients about the payment in kind to Smith along with an estimate of the value of those services. (Module 43.9, LOS 43: VI(C)) Question #16 of 39 Question ID: 1474448 An analyst who is a member of CFA Institute has composed an introductory information packet for her new clients, which includes information on fees she receives for referring clients to other professionals and those she pays for having clients referred to her. With respect to Standard VI(C), Referral Fees, this action: A) is not addressed in the Standard. B) C) may not satisfy the Standard if such information is only provided after the receivers of the information have become clients. exceeds the requirement of the Standard because she does not need to reveal the fees she pays to those that refer clients to her. Explanation Standard VI(C) says that a member must reveal information both on fees she receives for referring clients to other professionals and those she pays for having clients referred to her before a prospect becomes a client. This allows the prospect to evaluate any partiality of a recommendation and the full cost of the services. (Module 43.9, LOS 43: VI(C)) Question #17 of 39 Question ID: 1474433 A CFA Institute member makes a recommendation of a stock in which his firm has a material ownership, but neglects to inform clients of that ownership. The candidate has most clearly violated: A) Standard VI(A) - Disclosure of Conflicts. B) Standard III(B) - Fair Dealing. C) Standard V(B) - Communication with Clients and Prospective Clients. Explanation Standard VI(A)requires that members fully disclose all potential conflicts of interest, including ownership of stock in companies that the member recommends or that clients hold. Standard III(B), Fair Dealing, forbids members and Candidates from discriminating against any clients when disseminating recommendations or taking investment action. Standard V(B), Communication with Clients and Prospective Clients, requires that members disclose the general principles of the investment processes used, and distinguish between opinions and facts. (Module 43.9, LOS 43: VI(A)) Question #18 of 39 Question ID: 1474441 An analyst has the opportunity to offer his clients shares in a "hot new issue." One of the analyst's clients is his brother. When the new issue comes out, for those clients he deems it would be appropriate, he offers them an equal share. He includes his brother in that group. With respect to Standard VI(B), Priority of Transactions, this is: A) congruent with the Standard if his brother is not a 'covered person'. B) C) congruent with the Standard as long as he does not have a direct personal interest in his brother's account. congruent with the Standard even if he has a direct personal interest in his brother's account. Explanation Client accounts that belong to family members should be treated like any other account so long as there is no direct interest on the part of the analyst. In other words, these types of accounts should not be at a disadvantage relative to other client accounts when there is no direct interest on the part of the analyst overseeing the account. (Module 43.9, LOS 43: VI(B)) Question #19 of 39 Question ID: 1474425 Abner Flome, CFA, is writing a research report on Paulsen Group, an investment advisory firm. Flome's brother-in-law holds shares of Paulsen stock. Flome has recently interviewed for a position with Paulsen and expects a second interview. According to the Standards, Flome's most appropriate action is to disclose in the research report: A) that he is being considered for a job at Paulsen. B) his brother-in-law’s holding of Paulsen stock and that he is being considered for a job at Paulsen. C) his brother-in-law’s holding of Paulsen stock. Explanation The possibility of employment with Paulsen creates a potential conflict of interest which Flome must disclose. Standard VI(A) Disclosure of Conflicts does not require disclosure of his brother-in-law's ownership of Paulsen stock. (Module 43.9, LOS 43: VI(A)) Question #20 of 39 Question ID: 1474414 Jim Taylor works as a portfolio manager for Rose Capital and also serves as president of the Little League board of directors in his town. He receives no money from Little League, however the local golf club provides him with a free membership for volunteering his time on the Little League board. Taylor's involvement with Little League is in his company biography, but the club membership has not been disclosed to Rose or his clients. Taylor has: A) not violated the Standards. B) C) violated the Standards by not disclosing the club membership to Rose, but not by failing to disclose it to clients. violated the Standards by not disclosing the club membership to Rose and failing to disclose it to clients. Explanation He must disclose any compensation to his employer if it conflicts with his employers/clients interests. However, this relationship does not likely represent any conflict of interest. (Module 43.9, LOS 43.a) Question #21 of 39 Question ID: 1474428 Dwight Dawson, a CFA charterholder and portfolio manager at Ascott Investments, was recently appointed to the investments committee at Brightwood College. He will receive no compensation from Brightwood for serving on this committee. Another person at Ascott manages part of Brightwood's endowment. Dawson does not inform Ascott's compliance office of his involvement with Brightwood, because he does not believe doing so is necessary. Brenda Hamilton, a CFA candidate, also works for Ascott as an investment analyst. Procedures established at Ascott prohibit personal trading in securities analyzed or recommended by Ascott. One of these securities is Horizon, a telecommunications firm. Hamilton buys 10 shares of Horizon for her infant son's trust account. She believes that reporting this purchase to Ascott's compliance officer is unnecessary because the amount of the transaction is small and is not for her own personal account. Did Dawson or Hamilton's actions violate CFA Institute Standards of Professional Conduct? A) Dawson: No, Hamilton: No. B) Dawson: Yes, Hamilton: Yes. C) Dawson: No, Hamilton: Yes. Explanation Dawson violated Standard VI(A), Disclosure of Conflicts, by failing to inform Ascott of her involvement with Brightwood College. Dawson could reasonably be expected to be involved with investment policy decisions at Brightwood that could affect Ascott because Ascott manages a portion of Brightwood's endowment. Hamilton also violated Standard VI(A), because she ignored a directive of her employer. Her purchase of Horizon stock has an appearance of impropriety. Hamilton could discuss the purchase of Horizon stock with her firm's compliance officer and request an exception to the prohibition against personal trading in securities analyzed or recommended by Ascott. (Module 43.9, LOS 43: VI(A)) Question #22 of 39 Question ID: 1474440 An analyst, who is a CFA Institute member, manages a high-grade bond mutual fund. This is his only professional responsibility. When the analyst comes across a speculative stock investment that he feels is a good investment for his personal portfolio, the analyst: A) B) C) is in violation of Standard IV(A), Loyalty to Employer, by spending time analyzing stocks when he should only analyze bonds. must notify his supervisor about the stock according to Standard VI(B), Priority of Transactions, to see if it is appropriate for the portfolio that he manages. may invest in the stock because the analyst would not purchase the stock for the bond portfolio he manages. Explanation The problem says the analyst "came across" the speculative stock investment. We do not know if the analyst neglected his duties. Since such an investment is clearly not appropriate for a high-grade bond fund, the analyst may invest in the stock without any restrictions relating to the fund. (Module 43.9, LOS 43: VI(B)) Question #23 of 39 Question ID: 1474429 Bill Valley has been working for Advisors, Inc., for several years, and he just joined CFA Institute. Valley routinely writes research reports on Pharmaceutical firms. Valley has recently been asked to serve on the board of directors of an organization that promotes the search for a cure of a certain cancer. Serving on the board is an unpaid position without any direct benefits other than meeting new people and potential clients. To comply with Standard VI, Disclosure of Conflicts, Valley needs to: A) do nothing. B) both disclose the position on the board to his supervisor and describe his responsibilities on the board. C) only disclose the position on the board to his supervisor. Explanation Valley could be affected by his position on the board because he may tend to favor investments in firms that do cancer research. To comply with Standard VI(A), Disclosure of Conflicts, Valley must inform his supervisor of this relationship and describe his responsibilities on the board. Even if his supervisor does not find the relationship troublesome, any subsequent action that could lead to a conflict of interest should be discussed with the firm's compliance officer. (Module 43.9, LOS 43: VI(A)) Question #24 of 39 Question #24 of 39 Question ID: 1474439 Gordon McKinney, CFA, works in the trust department of a bank. The bank's trust account holds a large block of a particular company. McKinney learns that this company is going to buy back one million shares at a 15% premium to the market price on a first-come-firstserved basis. McKinney immediately tells his mother-in-law to tender her shares but waits until the end of the day to tender the trust's shares. McKinney has most likely violated: A) Standard IV(A), Loyalty to Employer. B) Standard VI(B), Priority of Transactions. C) Standard II(A), Material Nonpublic Information. Explanation Standard VI(B), Priority of Transactions, applies. If an analyst decides to make a recommendation about the purchase or sale of a security, he must give his customers or employer adequate opportunity to act on this recommendation before acting on his own behalf. Personal transactions include those made for the member's own account and family accounts. Here, McKinney violated Standard VI(B) by acting on his mother-in-law's behalf and then waiting until the end of the day to act on his employer's behalf. Explanations for other responses: Standard IV(A), Loyalty to Employer, does not apply. This standard concerns a member competing with his/her employer (independent practice), for example a member who engages in outside consulting. Standard II(A), Material Nonpublic Information, does not apply. The question does not indicate that the information is not public. (Module 43.9, LOS 43: VI(B)) Question #25 of 39 Question ID: 1474442 Standard VI(B), Priority of Transactions, applies to transactions an analyst takes on behalf of: A) both of these. B) his clients. C) his employer. Explanation Standard VI(B) addresses the treatment of both these accounts. The accounts of clients and employers have priority over personal accounts. (Module 43.9, LOS 43: VI(B)) Michael Pennington Case Scenario Michael Pennington is Senior Vice President of equity investments at Alpha Investment Advisors, Inc. (AIA). He manages a team of analysts and portfolio managers and is responsible for maintaining and developing client relationships. AIA is located in Belgium and provides investment management services to high net worth individuals. Pennington is also a Level III Candidate in the CFA Program. One of Pennington's clients is the Flanders family. Pennington had a long relationship with Helmut Flanders. Before Flanders's untimely death, he gave Pennington full discretion over his portfolio based on an investment policy statement that had been refined continuously over the years. Flanders was the president of a publicly traded manufacturing company, Allux, and 20% of his portfolio's assets were invested in Allux equity. His contract with Allux prohibited selling his Allux shares while he was employed. Flanders had little liquidity needs. His children were grown, and his salary at Allux was sufficient to cover his annual expenditures as well as contribute to his investment portfolio. A former accountant, Flanders had been extremely knowledgeable and comfortable with the investment decision-making process. Pennington owns 10,000 shares of Allux and serves on Allux's board and is part of the board's audit committee. Pennington came to know about some aggressive accounting choices made by Allux's CFO. Pennington played golf with Flanders on a regular basis and, with Flanders's help, developed many client relationships from these outings. AIA has an agreement with a local brokerage firm, First Brokerage, owned by Pennington's sister to place all AIA trades through First Brokerage. Flanders agreed in writing that all trades in his portfolio would be directed to First Brokerage. Pennington purchased new carpets for his office with soft dollars. He believes that his managers make better investment decisions when their environment is pleasant and comfortable. Pennington attended an industry conference in the Bahamas with soft dollars. The program is devoted to improving management of the investment advisory firm. He believes that a well-run firm makes better investment decisions. Pennington consistently uses soft dollars to purchase research reports from an independent research firm that does in-depth analysis of a company's financial reporting. Several of his managers have commented on the quality and usefulness of these reports to their analysis and decision making. After Flander's death, Pennington decided to sell all of his and his clients' holding of Allux shares. Pennington has an appointment to meet with Flanders's widow, Elise, who, as an artist, left management of their financial assets to her husband. She is meeting with Pennington to better understand her financial position. Question #26 - 29 of 39 Question ID: 1474408 Which of the following Standards is most relevant regarding Pennington's meeting with Elise? A) Standard III(A), Loyalty, Prudence, and Care. B) Standard III(C), Suitability. C) Standard III(E), Preservation of Confidentiality. Explanation Standard III(C), Suitability, is most relevant for Pennington's meeting with Elise. This Standard requires Pennington to make a reasonable inquiry into Elise's financial situation, investment experience, and investment objectives prior to making any recommendations about her portfolio. Pennington must also consider the appropriateness of the existing portfolio and investment policy statement for Elise. Standard III(A) also has some relevance since Pennington is in a position of trust with respect to Elise, and Pennington must ensure that his and AIA's goals do not conflict with Elise's. (Module 43.5, LOS 43.a) Question #27 - 29 of 39 Question ID: 1474409 Standard VI(A), Disclosures of Conflicts, requires Pennington to disclose all matters, including beneficial ownership of securities of other investments, that could be expected to impair the member's ability to make unbiased and objective recommendations. Which of the following matters would least likely be disclosed to Elise? A) AIA has a soft dollar arrangement with a brokerage firm owned by Pennington’s sister. B) Pennington owns shares in Allux. C) Pennington played golf with Helmut Flanders on a regular basis and developed client relationships from those golf outings. Explanation Pennington playing golf with Elise's husband Helmut Flanders is not a conflict with respect to his relationship with Elsie and he need not disclose to her that he played golf with Flanders. Flanders was his client at the time and there was full disclosure that Pennington developed new client relationships. Al the other matters must be disclosed. (Module 43.9, LOS 43.a) Question #28 - 29 of 39 Question ID: 1474410 Which of the following best describes Pennington's compliance with the CFA Institute Standards regarding his use of soft dollars? The purchase of: A) both research reports and carpeting are allowable uses of soft dollars. B) research reports and attending the conference are allowable uses of soft dollars. C) research reports is an allowable use of soft dollars. Explanation Brokerage is commission generated from trades and is an asset of the client not the investment manager. Soft dollars is the use of brokerage to purchase research services that benefit the client in the investment decision-making process. The investment manager has an ongoing responsibility to seek to obtain best execution, minimize transaction costs, and use client brokerage to benefit clients. Consequently, contingent on disclosure of a soft dollar arrangement to clients whose portfolios might be affected, the CFA Institute Standards permit client brokerage only to be used to purchase research; that is, goods and services, the primary use of which directly assists the investment manager in the investment decision making process and not in the management of the firm. (Module 43.4, LOS 43.a) Question #29 - 29 of 39 Question ID: 1474411 What additional Standard is specifically applicable to Pennington's decision to sell his and his clients' shares of Allux? A) Standard II, Integrity of Capital Markets. B) Standard IV, Duties to Employers. C) Standard VII, Responsibilities as a CFA Institute Member or CFA Candidate. Explanation As a director and member of Allux's audit committee, Pennington possesses material nonpublic information about a tender offer. Therefore, Pennington must be particularly concerned about complying with Standard II(A), Material Nonpublic Information. (Module 43.3, LOS 43.a) Question #30 of 39 Question ID: 1474434 When an analyst makes an investment recommendation, which of the following statements must be disclosed to clients? A) The firm is a market maker in the stock of the recommended company. B) Both of these statements must be disclosed to clients. C) An employee of the firm holds a directorship with the recommended company. Explanation Both of these items are explicitly listed in the discussion of Standard VI(A), Disclosure of Conflicts. (Module 43.9, LOS 43: VI(A)) Joan Platt, CFA, operates an investment firm in New York, but maintains an office in Xania. Platt's firm invests on its clients' behalf in both domestic and international stocks and bonds. Platt's employees include two analysts, Paula Linstrom, CFA, and Hershel Wadel, a member of the CFA Institute. Both analysts report to Platt directly. Thorvald Knudsen, CFA, manages the international bond portfolio. Xania recently established a stock market, which is not very efficient. None of the Xanian stocks trade in the U.S. market. Xania legally permits the use of material inside information. Platt believes that using inside information would help her compete against other Xanian investment advisers, and also help some of her Xanian clients reach their investment objectives. Platt instructs Wadel to write a research report on Gamma Company. Wadel's wife inherited 500 shares of Gamma Company from her father when he died five years ago. Gamma stock currently sells for $35 a share. Wadel does not believe that informing Platt about his wife's inheritance is necessary. Doris Black, one of Wadel's long-time clients, verbally promised Wadel that he could use her vacation home in Aspen, Colo., for a week during skiing season if the return on her portfolio exceeded its benchmark by two percentage points during the next year. Black also promised to reimburse Wadel for his travel expenses. Because Wadel is the sole manager of Black's portfolio, he says nothing to Platt about his arrangement with Black. Platt instructs Linstrom to write a research report on Delta Enterprises. Delta's stock is widely held by institutional and individual investors. Linstrom does not own any Delta shares, though one of her friends owns 100 shares of Delta. Linstrom does not believe that informing Platt about her friend's ownership of Delta shares is necessary. Platt suspects that one of the firm's unpaid interns has violated a federal securities regulation. Question #31 - 34 of 39 Question ID: 1474416 Regarding their research reports, which of the following statements about Linstrom and Wadel's conduct is CORRECT? A) Both Linstrom and Wadel violated Standard VI(A)—Disclosure of Conflicts. B) C) Wadel violated Standard VI(A)—Disclosure of Conflicts, and Linstrom did not violate Standard VI(A). Wadel did not violate Standard VI(A)—Disclosure of Conflicts, and Linstrom did violate Standard VI(A). Explanation Wadel violated Standard VI(A) by not disclosing his wife's holdings. Linstrom is not in violation of the Standard because a friend's ownership of the shares should not be expected to impair her ability to make objective decisions. (Module 43.9, LOS 43.a) Question #32 - 34 of 39 Question ID: 1474417 What is the obligation, if any, to disclose Wadel's arrangement with Black? A) B) C) Wadel must disclose the arrangement to Platt but is not required to disclose the arrangement to his other clients. Wadel need not disclose anything to his clients or to Platt because he is violating no fiduciary duty. Wadel must disclose the arrangements to his clients and to Platt only if he believes it will create a conflict with his responsibilities to other clients. Explanation Wadel is required to disclose the arrangement between him and Black under Standard IV(B)—Additional Compensation Arrangements, regardless of whether or not the compensation is cash or noncash. Under Standard I(B)—Independence and Objectivity, members may accept bonuses or gifts from clients, so long as they disclose them to their employers, because gifts in a client relationship are deemed less likely to affect a member's objectivity and independence than gifts in other situations. Token gifts need not be disclosed. (Module 43.7, LOS 43.a) Question #33 - 34 of 39 Question ID: 1474418 According to the Standards, how must Platt deal with the intern's alleged illegal activity? A) Initiate an investigation and place limits on the intern’s activities pending the outcome. B) Report the intern’s behavior to the appropriate regulatory authority. C) Tell the intern to stop the conduct. Explanation Platt must initiate an investigation, and must also take steps to ensure that additional violations do not occur during the investigation. The investigation could be handled internally by the firm's compliance officer, or could involve outside legal counsel. Simply instructing the intern to stop the conduct is not sufficient—the Standards require a more proactive response. Reporting the intern to the authorities is not appropriate because Platt is not sure the intern is violating the law. The fact that the intern is not paid does not absolve Platt or her company from liability for the intern's actions. (Module 43.7, LOS 43.a) Question #34 - 34 of 39 Question ID: 1474419 Platt is renouncing her U.S. citizenship and becoming a citizen of Xania. According to the Standards, if Platt renounces her U.S. citizenship, she may then: A) use material inside information when trading in Xania only if the information does not relate to a tender offer. B) not use material inside information when trading in Xania. C) not use material inside information unless trading Xanian stocks exclusively. Explanation Standard II(A)—Material Nonpublic Information does not allow the use of material nonpublic information in investment decisions. Platt is bound by the law of the land if it is stricter than the Standards, and by the Standards if they are stricter than the law. Since the Standards are stricter than Xanian law, Platt's Xanian operations are governed by the Standards. Thus, she cannot use material nonpublic information under any circumstances. (Module 43.3, LOS 43.a) Question #35 of 39 Question ID: 1474412 Steve Copper has worked as an independent consultant for the past ten years advising companies on various ways to increase their internal efficiency and thereby increase the firm's stock price as well. Copper recently accepted a job offer from an equity research firm as a senior stock analyst. One of the firms he will be responsible for researching, Johnson Machine Tools (JMT), is also one of his consulting clients. Copper currently has a contract with JMT to provide consulting services for another six months which he plans to honor even though there are no penalties in the contract for early termination on his part. According to CFA Institute Standards of Professional Conduct, which of the following is the most appropriate action for Copper to take? Copper should: A) disclose the arrangement only if he plans to renew the contract in six months. B) terminate the contract with JMT prior to issuing any research on the company. C) disclose the consulting arrangement to clients considering JMT as an investment. Explanation Standard VI(A)—Disclosure of Conflicts requires members and candidates to inform clients, prospects, and their employers of any situation that may impair their independence and objectivity or interfere with duties owed to the same groups. The Standard notes that best practice is to avoid conflicts of interest when possible. This best practice recommendation is consistent with Standard I(B) – Independence and Objectivity, which requires that independence and objectivity be maintained. The consulting arrangement with JMT, a company about which Copper will write research reports, divides his loyalty between JMT and the clients purchasing Copper's research on the same company. This is a clear conflict of interest which must be disclosed to clients, prospects, and Copper's employer if the conflict cannot be avoided. However, there is no penalty for ending the consulting relationship and best practice would dictate that Copper terminate the contract with JMT. (Module 43.9, LOS 43.a) Question #36 of 39 Question ID: 1474437 An analyst likes to trade commodity futures in her own account. She does not deem any of her client accounts suitable for commodity futures trading. When she identifies a favorable commodity futures position, the Standard concerning priority of transactions suggests she should: A) refrain from acting until she notifies her supervisor. B) act on it on her own behalf as she sees fit. C) first tell her clients about it before acting herself. Explanation The analyst's commodity futures trading is not a violation of Standard VI(B) Priority of Transactions because the investment is not suitable for her clients. If the analyst believes that none of her clients should trade commodity futures, she is not obligated to advise them of her own investments in them. (Module 43.9, LOS 43: VI(B)) Question #37 of 39 Question ID: 1474438 An analyst routinely has the opportunity to offer his clients the opportunity to purchase "hot new issues." He tells his clients that he will distribute each issue equally among those interested, with himself included in the distribution. The clients do not object to this. With respect to Standard VI(B), Priority of Transactions, this: A) may be a violation despite the clients' approval. B) may be a violation because it is impossible to distribute hot new issues equally. C) cannot be a violation because the clients know of the practice and agree. Explanation Just because the clients know of a practice does not make it right. The analyst must put the clients first. It is a violation for the analyst to participate in a "hot new issue" which can lower the allocation to any given client below what that client would prefer. This is tantamount to putting the analyst's interests ahead of the clients' interests. (Module 43.9, LOS 43: VI(B)) Question #38 of 39 Question ID: 1474436 The following scenarios refer to two analysts who are employed at Global Securities, a large brokerage firm. Paula Linstrom, CFA, is instructed by her supervisor to write a research report on Delta Enterprises. Delta's stock is widely held by institutional and individual investors. Although Linstrom does not own any of Delta's stocks, she believes that one of her friends may own 10 shares of Delta. The stock currently sells for $25 per share. Linstrom does not believe that informing her employer about her friend's possible ownership of Delta shares is necessary. Hershel Wadel, a member of CFA Institute, is asked by his supervisor to write a research report on Gamma Company. Wadel's wife inherited 500 shares of Gamma Company from her father when he died five years ago. Gamma stock currently sells for $35 per share. Wadel does not believe that informing his employer about his wife's ownership of Gamma shares is necessary. According to CFA Institute Standards of Professional Conduct, which the following statements about Linstrom and Wadel's conduct is most accurate? A) Both of these analysts must disclose a potential conflict of interest. B) Neither of these analysts must disclose a potential conflict of interest. C) Only one of these analysts must disclose a potential conflict of interest. Explanation The possibility that Linstrom's friend may own shares of Delta's stock does not create a conflict of interest for Linstrom, who has no beneficial interest in these shares. On the other hand, Wadel has a beneficial interest in his wife's ownership of Gamma shares. Standard VI(A) Disclosure of Conflicts requires that Wadel disclose this information so that his employer can make the proper determination. (Module 43.9, LOS 43: VI(A)) Question #39 of 39 Question ID: 1474426 The following scenarios involve two analysts at Dupree Asset Management, a small New York-based company with about $150 million in assets under management. Dupree restricts personal trading of stocks analyzed, corporate directorships, trustee positions, and other special relationships that could reasonably be considered a conflict of interest with their responsibilities to their employer. Ray Bolt, CFA, is a senior investment analyst. Bolt was recently elected to the board of trustees of his alma mater, Midwest University, and was appointed as the chairman of the University's endowment committee. Midwest has more than $2 billion in its endowment. Bolt must travel from New York to Chicago eight times a year to attend meetings of the board of trustees and endowment committee. Bolt did not inform Dupree of his involvement with Midwest University. Wanda Delvecco, a candidate in the CFA Program, is a junior investment analyst. She recently wrote a research report on Aveco Communications and recommended the stock for Dupree's "buy" list. Delvecco bought 200 shares of Aveco stock for her personal account 12 months before she wrote her research report. Over the past 12 months, the stock's price has been in the $20-42 price range. Delvecco has not informed Dupree of her ownership of Aveco stock. According to CFA Institute Standards of Professional Conduct, which the following statements about Bolt and Delvecco's actions is CORRECT? A) Neither Bolt nor Delvecco violated the Standards. B) Both Bolt and Delvecco violated the Standards. C) Delvecco violated the Standards, but Bolt did not. Explanation Standard VI(A), Disclosure of Conflicts, requires that Bolt inform Dupree of his involvement with Midwest University given that Bolt's new role can be expected to be time consuming and possibly affect his responsibilities at Dupree. Delvecco is required to disclose her ownership of Aveco stock before conducting the research report because such ownership could bias her objectivity in making a recommendation. She should have discussed owning the stock with her supervisor before beginning to write the research report on Aveco. (Module 43.9, LOS 43: VI(A))