CFA Level II Ethics: Nuances, Edge Cases, and Pattern Recognition

CFA Level II Ethics: Nuances, Edge Cases, and Pattern Recognition A study companion built from the 12th edition Standards of Practice Handbook, focused exclusively on the subtle interpretations, gray areas, and unintuitive distinctions that Level II actually tests. Assumes you already have the Standards memorized. How to use this document For each Standard, three things are extracted: 1. Conceptual nuances — points buried in the guidance language that the standard itself doesn't telegraph. 2. Application patterns — the exact distinctions the handbook draws across its examples, organized by recurring themes (it's the application examples, not the guidance, that drive most exam questions). 3. Traps and tells — the specific wording, fact patterns, and red herrings that signal a violation vs. compliance. Pattern recognition matters more than memorization at Level II. The same underlying nuance is recycled across many fact patterns; once you see the pattern, the question becomes mechanical. STANDARD I: PROFESSIONALISM I(A) Knowledge of the Law Conceptual nuances that aren't obvious from the standard You are not required to be a compliance expert. The standard says "understand and comply with all applicable laws, rules, and regulations," but the handbook explicitly says you do not need to become an expert in compliance, nor in every law that could conceivably govern your activities. The required level of knowledge depends on your role and responsibilities — a back-office analyst doesn't need detailed knowledge of employment law, but a manager supervising many employees does. "Knowingly" includes "should have known." The standard applies when a member knows or should know that conduct may contribute to a violation. Willful blindness is not a defense. Reliance on legal counsel is recommended but does not absolve you. If your firm's general counsel says "this would be hard for the regulator to prove," that opinion doesn't insulate you. You must still report up, seek independent legal advice, and consider notifying the regulator yourself. The phrase "I asked the lawyer" is a recurring trap — counsel's opinion is a starting point, not an end point. Code & Standards govern when the law is silent or weaker. When local law has no rule on a given topic, or has a weaker rule than the Code & Standards, the Code & Standards apply. Members are not free to fall back on minimum local law. The "more strict" rule — the part candidates most often trip on This is one of the most heavily tested gray areas. The handbook gives a 9-row table on this. The correct mental model has three layers: 1. Where does the member live? (NS = no securities laws; LS = less strict than Code; MS = more strict than Code) 2. Where is the business conducted? 3. What does the applicable law itself say about choice of law? This is the trick — applicable law sometimes specifies that another jurisdiction's law governs (e.g., "the law of the locality where business is conducted" or "the law of the client's home country"). When that happens, you follow the chain of pointers, then compare the resulting governing law against the Code & Standards, and apply whichever is stricter. A frequently-missed pattern: a member resides in MS country, does business in LS country, but MS law says "the law of the client's home country governs." If the client is from MS country, MS law (stricter) applies. If the client is from LS country, the Code & Standards apply (because Code is stricter than LS). The "stricter" test is functional: the rule that imposes greater restriction or requires greater action to protect the client wins. A common worked example: a jurisdiction may not require disclosure of referral fees; the Code does. Code wins. Dissociation — the procedural trap The standard says you "must dissociate." The nuance is in how. First step is internal escalation, not immediate departure: try direct discussion, then bring it to a supervisor or compliance, before stepping away. Dissociation differs by role. Examples include: removing your name from a report, asking for a different assignment, refusing a new client, refusing to use misleading marketing material. In extreme cases, leaving employment. Inaction + continued association = participation. You cannot be passively associated with ongoing wrongdoing. Silence becomes assistance. Document the dissociation. This is in the compliance practices. Reporting to government regulators is not required unless local law mandates it — voluntary reporting (whistle-blowing) is encouraged where prudent but not compelled by I(A) itself. Reporting violations of fellow members to CFA Institute is encouraged but not required. The handbook explicitly says failure to report is less likely to be construed as a violation than failure to dissociate. Patterns from the application examples Misleading promotional material (Washington case): if you didn't compute the inflated number yourself but use it in solicitation, you're assisting the violation. The remediation chain: discuss with the person responsible → escalate to supervisor/compliance → refuse to use the material → consider leaving. Misleading prospectus (Brown/Courtney case): report to supervisor; if firm doesn't dissociate from the underwriting, you must "sever all connections with the underwriting" (not necessarily quit) — and seek legal advice on additional reporting. Stricter local law applies even if you think your home country's law should govern. Jameson, a US citizen working in Karramba, can't just use US law — Karramba's prohibition on registered investment advisers participating in IPOs binds her. Her good-faith belief about which law applies doesn't matter. Failure to keep up with regulatory developments in your area (e.g., new social-media rules) is itself a violation, even without a deliberate violation. This dovetails with I(E) Competence. Knowing your industry's specific laws. A pension portfolio manager has to know audit regulations relevant to that activity. The duty is targeted to your professional responsibilities. Traps to watch for "He relied on his attorney's opinion" — never sufficient. "There is no local law against this" — the Code still applies if it's stricter. "It's customary in my country" — irrelevant. "The firm's counsel said it would be hard to prove" — this is the textbook signal of a violation in progress. I(B) Independence and Objectivity Conceptual nuances The standard targets anything that could reasonably be expected to compromise independence — actual compromise is not required. Modest gifts and ordinary business entertainment are permissible. The handbook is explicit: do not refuse all gifts. The line is at "token" items and at entertainment whose purpose is not to influence or reward. Three-way distinction between gift sources is the key fault-line: From clients — treated as supplementary compensation; permissible if disclosed to employer (because the existing compensation arrangement reduces the influence concern). From entities seeking to influence the member — much more restricted; firm policy may forbid entirely. From the member's firm to influence others — likewise restricted (this is the manager-selection / pay-to-play dimension). Compensation arrangements — the "must-avoid" vs. "must-disclose" line This is a critically tested distinction. The handbook draws a sharp line: Compensation tied to the conclusions of an analyst's research or to specific outcomes (e.g., bonus per new investor attracted; equity warrants in a covered company) — must be AVOIDED. Disclosure is not enough. The Herrero example (paid by an investor relations firm with a flat fee plus a bonus per new investor) makes this explicit: the bonus structure cannot be salvaged by disclosure. Issuer-paid research with a flat fee, no contingent payments — permissible if disclosed. The flat fee is the safe harbor. Supplementary compensation from a client (e.g., performance-linked bonus from a portfolio's beneficial owner) — permissible if pre-disclosed to the employer (because the gift comes from someone whose interests already align with yours). Travel and accommodations A nuanced area; the handbook isn't categorical. Best practice: member or firm pays for commercial transportation and hotel. No corporate issuer should reimburse air transportation. This is stated as a flat compliance practice. Modestly arranged travel (not lavish) on a chartered flight to a property/mine where commercial transport doesn't reach — permissible, with caveats. The Taylor (Precision Metals) example is the leading case: chartered flights to mine sites, modest hotels, three nights — Taylor did not necessarily violate, but Adams (who paid his own hotel bill) demonstrated best practice. Lavish or unrelated trips violate the standard. The Grant (World Cup tickets, resort, limousine) example crosses the line — substantial gifts impede objectivity. Pension officers accepting partly-funded fact-finding trips (Wayne/Penguin Advisers) — even though the trip was educational and run by an independent academy, the fact that a candidate manager funded it tainted the manager-selection decision. The fix: have the employer/plan pay basic expenses; limit contact with the funding manager to information events; make the trip and sponsor a matter of public record. Manager-selection conflicts Watch for the following recurring pattern: A member working in hiring capacity (pension fund, endowment, investment committee) must not solicit gifts, contributions, or political/charitable donations that could influence the decision — even if those don't benefit the member personally. Asking a manager to donate to your favorite charity is a solicitation that can compromise objectivity. A member trying to win business must not offer gifts, donations, or contributions to the hiring representative or to charities/political candidates the hiring representative names. The Mandel/Gomez/UDPBU example: contributions to a union leader's reelection campaign and lavish entertainment to keep the relationship — violation. Pay-to-play scandals (US public pension funds): contributing to political campaigns of officials who control hiring decisions = violation. Issuer-paid research An issuer-paid analyst can be objective only if compensation is a flat fee, fully disclosed, and the analyst exercises diligent independent analysis. Direct payment based on conclusions = not permissible. Indirect payment (warrants, equity that gains value from positive coverage) = not permissible. The McGuire example couples this with I(C): operating a "seemingly independent" issuerpaid research site without disclosure violates both I(B) (the conflict) and I(C) (the misrepresentation of independence). Internal-pressure patterns from the examples Investment-banking pressure to be favorable on a covered company (Fritz/Metals & Mining): must remain objective; remedy is to put the company on a restricted list in anticipation of an underwriting. Issuer-relationship pressure (CEO will cut you off from calls): still must be objective; document your reasoning carefully. Sales pressure to push inventory (Warner/Milton bonds): refuse unless market price already reflects the issue. Boss instructs you not to change a "buy" rating (Jorund/International Airlines): two acceptable paths — (i) tell boss you can't cover under that constraint, or (ii) take coverage, reach your own conclusion, and share the conclusion up the chain. Issuing an opinion you don't hold = violation. Performance analyst pressured to remove an account from a composite to make returns look better (Stein): must refuse. The composite belongs to the strategy, not to whichever client's underperformance embarrasses sales. Performance analyst spotting that an external manager moved a bad account into a residual composite (Scott): must disclose in the analysis even if the external manager is the CEO's friend. Gift from existing client (e.g., Wimbledon tickets and use of a London flat from a satisfied client) — permissible if disclosed to the employer. Reason: the client already has a compensation relationship with the firm; the gift is supplementary compensation. Disclosure lets the employer monitor for favoritism toward this client to the detriment of others (e.g., over-allocating IPO shares). Same gift from a non-client trying to win business — analyzed differently; usually a problem. Traps and tells "In appreciation of all the business..." from a brokerage = the gift is from someone trying to influence future commission flow, not a client → must avoid or rigorously disclose. "Two tickets to the World Cup, two nights at a resort, limousine..." = the lavishness signals violation regardless of the relationship. "As a reward for performance" from an existing client = supplementary compensation; disclose. "The trip was strictly for business, accommodations were modest" = signal of compliance, not violation. Compensation linked to "the performance of the stock" or to "new investors attracted" = must avoid (cannot be salvaged by disclosure). Compensation that is a flat fee = generally salvageable with disclosure. Contributions to a politician/charity named by the hiring representative = violation regardless of whether the member personally benefits. I(C) Misrepresentation Conceptual nuances Misrepresentation includes omission. Any statement, written or verbal, that is false, misleading, or omits material facts is a misrepresentation. The standard is not limited to outright lies. "Knowingly" includes "should have known." A senior official who repeatedly distributes promotional material with errors (Muhammad/advanced-degree case) is held to "should have known" even if the marketing department drafted it. Plain language is required. Communications must be accurate, timely, complete, and in plain language. "Plain" means clear and concise, common words, not dominated by jargon. Standard I(C) does not require providing a benchmark in performance reporting. Some strategies (complex hedge funds) genuinely lack appropriate benchmarks. If you do use a non-comparable benchmark (e.g., "cash plus" for a hedge fund), you must explain why. You cannot guarantee returns or capital preservation, with one carve-out: products with an actual structural guarantee (FDIC-insured deposits, products where an institution has agreed to cover losses) — describing those as "guaranteed" up to the insured limit is acceptable. Abdrabbo's recommendation of FDIC-insured CDs as "guaranteed" up to the limit is permissible because the structural guarantee actually exists. Pricing-source shopping is misrepresentation. Switching pricing providers solely because the new one reports a higher value of an illiquid security distorts NAV, can lead to overcharging on advisory fees, and misleads clients about portfolio worth. Consistency in valuation methodology is the rule. Cherry-picking accounts in a composite (Palmer): excluding underperforming accounts from databases or external reporting is a misrepresentation of the firm's track record. Switching attribution methodology to make returns look better ties to III(D) but is also a I(C) issue when packaged in client communication. Plagiarism — the most heavily examined area within I(C) Substantial-form copying without acknowledgment is plagiarism. This includes (i) verbatim or near-verbatim use of text, (ii) citing "leading analysts" without naming them, (iii) presenting others' forecasts without their qualifying caveats, (iv) using charts/graphs without sourcing, (v) copying spreadsheets/algorithms without permission. Tested-and-modified models are still plagiarism if the conceptual idea isn't credited. Browning/Jorrely: testing a quant model from a seminar, making minor changes, and announcing "I have discovered a new model" — must credit Jorrely for the innovation. Browning can take credit for the testing and final practical results, but not for the underlying idea. Plain-language descriptions of basic concepts (P/E ratio, standard deviation as risk) are still copyrighted text. Verbatim copying without attribution = violation. Best practice: rewrite in your own words or cite the source. The Zubia example holds even though the concepts are general. Citing a study you read about in a newspaper: best practice is to obtain the original from the author, review it, and cite it directly. If you do that, you don't need to cite the newspaper. If you only have the newspaper, cite both the newspaper and the study (Schneider example) — and note that you risk relying on second-hand information that may have errors. Repackaging third-party research: OK to distribute outsourced research if you don't represent yourself as the author. Ostrowski's two-person firm distributing a large research firm's reports as its own = violation. The fix: tell clients the research is from a third party, and that your value-add is in selecting and curating it. In-firm research after the original analyst leaves: the firm owns the research; the firm can issue future reports without attribution to the prior analyst. But the prior member or candidate must not reissue a previously released report solely under his or her name (i.e., you cannot rebrand someone else's work as yours). Acquisition reports / prepared analyses given to your firm by a client (Swanson/Ballard/Apex/Davis): if your boss says "use the Davis report, change a few words, sign your name" — that is plagiarism. The fix: cite Davis where you agree, add your own analysis and conclusions before signing. Drilling-data added to another analyst's report (Grant/Jefferson Mining/Barton): even if you supplement the underlying report with your own work (a phone call to the company), reissuing Barton's substantial work under your name is plagiarism. Investment performance, products, and the "guaranteed" trap Misrepresenting the nature of an instrument: the Marks/IO-strips example. Calling mortgage-backed interest-only strips "guaranteed by the US government" is a misrepresentation: only the underlying mortgages are guaranteed, not the interest stream or the principal investment. The product can be wiped out by prepayment risk despite the underlying federal guarantee. Misrepresenting the firm's services (Rogers): "we can perform all the financial and investment services you need" oversells a small firm with no tax planning capability. Stick to specifics. Misrepresenting how the firm is staffed (Stafford/Angelwood): advertising "personally involved in all client work" while transitioning over 50% of work to third-party contractors is misrepresentation by omission. Even if the contractors are qualified and the engagement letter allows discretionary staffing, what was promised in marketing was personal involvement. Errors and updates Unintentional errors are not violations of I(C). Yao's typo (¥350bn vs. ¥35bn) was an unintentional misrepresentation that, on its own, is not a violation — but Yao must take steps to (i) cease distribution, (ii) correct the error, (iii) notify recipients. Failure to remediate would convert the unintentional error into a violation. Outdated material that you know is outdated = violation. Finch (sales director) knowingly distributing fact sheets from mutual fund firms that he knows have changed strategy (e.g., fund now uses leverage) = violation. Even though his bank doesn't author the marketing material, his firm's continued distribution is the misrepresentation. Outdated performance history on your website (Huggins/global-pandemic): the 5-year history was accurate when first posted, but performance has dropped sharply since. Continuing to show the older numbers without updating = misrepresentation by failure to provide accurate, timely information. Misrepresenting risks and ESG claims Hamilton (private equity ESG fund): giving prospective investors only general information while showing detailed reports (with overweights to risky tech) only to committed investors. Limiting information to prospects is permissible up to a point, but cannot rise to misrepresenting the nature or level of risk. ESG-washing (Lowery/Majesty Fund): advertising "proactive engagement and proxy voting" and not doing it = violation. Members must not overstate sustainability/ESG credentials. Using AI / generated content Al-Wazir / ChatGPT: using ChatGPT to fake competence in an RFP about AI investment processes is a misrepresentation of the firm's capabilities and of his own knowledge. The use of AI to dress up superficial knowledge is the trap. Manager-distribution misrepresentation (I(C) crossed with III(B)) Open Air Bank / Stafford (Appleton): the bank was promoting structured securities to offshore clients with a much more conservative profile than the actual investment policy, plus an inflated independent rating. Stafford, as part of the investment team, recognized the problem; supervisor brushed him off (citing offshore regulatory regime and a footnote on page 184 of the prospectus). Stafford must keep escalating; he cannot be associated with promoting a misleading product. Traps and tells "I can guarantee 8% on equities..." = violation. "We can perform all financial services..." = imprecise → violation when the firm cannot. "The independent rating shows..." when the rating was procured to inflate value = violation. "Slight changes to the model..." without crediting source = plagiarism. "Unlimited engagement and proxy voting" that isn't being done = ESG-washing → violation. "Used ChatGPT to draft the RFP answer about AI" = misrepresentation of expertise. "Charts the firm's performance using its highest-performing accounts" = cherry-picking → violation. "Cited the study from the FT" without obtaining the original = at minimum should cite both sources. I(D) Misconduct Conceptual nuances The standard is limited to professional conduct, not personal life. Personal misbehavior is captured only when it (i) involves the workplace/academia/investment-industry participation, OR (ii) explicitly or implicitly uses the CFA charter, CIPM designation, CFA membership, or CFA candidacy. The Code & Standards are not a tool for settling personal scores. The handbook explicitly notes that PCP has procedures to deter abuse of I(D) for personal/political disputes. "Honest mistakes" and ordinary failings are not the target. Civil disobedience for personal beliefs (Garcia/environmental protests) is not covered, because such conduct does not reflect on professional reputation, integrity, or competence. What counts as "professional" The handbook gives an explicit list of activities that fall within professional conduct: 1. Interactions with colleagues, employees, or clients in the workplace or academia. 2. Activities where the member represents themselves as a charterholder, candidate, or member. 3. Conduct as an unpaid CFA Institute or local society officer/representative/volunteer. 4. Conduct at CFA Institute / local society / industry meetings, courses, conferences, events. 5. Writing about investments or markets in articles, books, message boards, blogs outside the workplace or academia. 6. Communicating with a government agency, regulator, or other professional organization regarding information within the scope of professional responsibilities. The pattern: when is non-workplace conduct "professional"? This is where the application examples earn their keep. Sasserman (drinking at country club, returning intoxicated to make investment decisions): professional conduct — the on-the-job intoxication impairs ability to fulfill duties. Violation. Hoffman (altering medical reimbursement bills): workplace fraud, even though unrelated to investment recommendations, reflects on integrity. Violation. Brink (volunteer charity board, kickback on van purchase): the volunteer position was secured because of her status as an experienced CFA charterholder, so it counts as professional conduct. The kickback is fraud and self-dealing. Violation. Garcia (environmental activist, repeatedly arrested for nonviolent trespass): civil disobedience for personal beliefs is not I(D) conduct. Not a violation. O'Hara (sexual harassment as a society volunteer instructor): professional conduct because (i) it occurs in the local society's CFA Program review course, (ii) encompasses use of his charter and society membership. Violation. Nehjer (retired charterholder, op-ed against casino, fabricated statistics, signed "PhD, CFA"): retirement does not exempt — she explicitly used her charter to lend credibility. Fabricating data is fraud and misrepresentation. Violation. Mewis (CFA candidate, personal blog, false ESG attack on ex-husband's company): even though the work is unrelated to her employer's mandate, the conduct is in the investment profession (writing investment opinions in security markets). The dishonesty and personal motive convert it into professional misconduct. Violation. Tan (CFA candidate, fraudulent disabled parking permit): dishonest and deceitful, but not connected to the investment profession or the CFA Program. Not a violation — though the handbook calls it "deplorable." Mondelo (security analyst, election-day violence and lying to investigators): despite his prominence in the industry and being fired, the activity is unrelated to employment, investment profession, charter, or CFA Institute. Not a violation under I(D). But: if convicted of a crime punishable by more than one year in prison, he could be summarily suspended under the Rules of Procedure for Conduct Related to the Profession. The exam loves this distinction — I(D) and the Rules of Procedure are separate machinery. Traps and tells "At the country club, returning to work intoxicated" = professional conduct (at-work impairment). "At the local society as a volunteer instructor" = professional conduct. "As a volunteer board member because of her CFA experience" = professional conduct. "Out-of-work environmental activism with arrests" = NOT professional conduct. "Off-the-job traffic / parking violation" = NOT professional conduct. "Off-the-job political violence" = NOT I(D), but possibly summary suspension under separate Rules of Procedure. "Posting investment opinions on a personal blog with malicious false statements" = professional conduct (it's investment-profession participation). "Signing a fabricated op-ed as 'PhD, CFA'" = professional conduct (using the charter). The clearest mental rule: ask whether the conduct involves the workplace, the investment profession, or invokes the charter/membership/candidacy. If none of those, I(D) does not bite — even if the conduct is dishonest. I(E) Competence (NEW in the 12th edition) Conceptual nuances Lack of competence is not measured by outcome. A competent manager may make money-losing trades; a competent analyst may fail to predict the future. The Mifune (Vouchsafe Insurance) example: thorough research that failed to uncover a CFO's fraud does not, by itself, demonstrate incompetence. Competence is role-specific. What's required differs by job. The handbook's three pillars: knowledge (information used), skills (capability to perform), abilities (attitudes/behaviors that produce observable outcomes). Education ≠ competence. A highly educated investment consultant may lack experience in a new practice area; an audit professional may not be competent in GIPS compliance assessment; an ESG-focused mandate requires ESG-specific knowledge. No mandated continuing-education program. The standard does not require any specific certification or PD plan. Members can demonstrate and maintain competence in many ways. Competence must be maintained over time. Roles change; knowledge required changes; the duty is continuous, not satisfied by a one-time qualification. Application patterns Lee (geopolitical consultant, new trade deal): reading the agreement, consulting field experts, validating understanding — complies. Choe (research director, ESG ratings): hired an ESG specialist, required all analysts (including herself) to attend ESG seminars and earn an ESG certificate before incorporating ESG. Complies. Glusker (regulatory attorney transitioning to sales): passed the licensing exam without learning the material, relied on industry experience. Passing alone is not enough; he doesn't actually know the rules. Violation. Evans (analyst promoted to director with supervisory responsibility): got up to speed on existing research projects but didn't gain knowledge about managing employees, leading teams, or supervisory compliance requirements. New role demands new competence. Violation. Mifune (recommended Vouchsafe insurance, company collapsed due to undiscovered CFO fraud): thorough research that failed to detect industry-wide-fooled fraud does not, by itself, indicate incompetence. Not a violation. Halsey (cryptocurrency for clients despite limited knowledge): generally aware, read articles, but didn't understand the asset or differences between products. Bought a heavily promoted product to avoid losing clients or seeming out of touch. The unfamiliar territory + hasty decision + market-trend pressure = textbook violation. Cross-references I(E) is closely tied to I(A) — failure to maintain knowledge of applicable laws is also a competence issue (the White social-media example explicitly cites I(E)). I(E) is tied to V(A) — lacking the knowledge to understand a quantitative model overlaps with the diligence requirement. I(E) is tied to I(B) — being pressured into an investment in an area you don't understand is both an independence and a competence issue. Traps and tells "Hastily invests in unfamiliar product to keep clients / not miss trend" = violation. "Passed the licensing exam but never learned the material" = violation. "Promoted to a supervisory role with no preparation for management duties" = violation. "Thorough research that nonetheless failed to uncover hidden fraud" = NOT a violation. "Hired a specialist and got training before incorporating new factors" = compliance. STANDARD II: INTEGRITY OF CAPITAL MARKETS II(A) Material Nonpublic Information What "material" actually means The handbook gives an explicit list, but the deeper test is: would the information significantly alter the total mix of available information so that the security price would be affected, or would a reasonable investor want it before deciding? Materiality factors that move the needle: Specificity — "earnings will be 5 cents below consensus" is more material than "earnings might disappoint." Difference from public information — incremental information matters less than information that contradicts public guidance. Nature of the information — categories the handbook lists: earnings; M&A/tender offers/JVs; asset changes; new products / discoveries / drug trials; new licenses or patents or regulatory approval/rejection; major customer/supplier wins or losses; management changes; auditor changes or qualified opinions; events involving the issuer's securities (defaults, calls, repurchase, splits, dividend changes, rights changes, public/private sales); bankruptcy; legal disputes; government economic reports; large pending trades; new thirdparty ratings/recommendations. Reliability of the source — a CEO's tip is more reliable (and more material) than a competitor's speculation. A doctor's casual market commentary about an industry takeover is unreliable enough that the handbook's Fechtman example treats it as not material. Ambiguity of impact — if it's unclear whether and to what extent price is affected, it may not be material. What "nonpublic" actually means "Disseminated" = made known. A press release plus a regulatory filing satisfies this. A disclosure to "a small group forum" — even a room of analysts — does not. You don't have to wait for the slowest delivery method. Members must have a reasonable expectation that recipients have actually received it before treating as public. Selective disclosure to a privileged group (analysts, the 10 largest shareholders) is not public dissemination. The Levenson/Taiwanese-finance-director example: invitation-only briefing to the 10 largest shareholders revealing a workforce strike — not public; cannot trade. When MNPI is permissible to use Legitimate due diligence under a business agreement — M&A, loan underwriting, credit ratings, offering engagements. The information can be used for that specific purpose only. Trading on it (or inducing others) is a violation. Once disseminated — it's no longer covered. Mosaic theory — the core protection for analysts Analysts may piece together public information and nonmaterial nonpublic information, even if the resulting conclusion would have been material if disclosed directly by the company. The Teja/Swan Furniture example: financial reports, factory visits, designer/retailer conversations about consumer demand, an independent profit-and-loss analysis → conclusion that next-quarter earnings will drop. The earnings number itself, if leaked, would be MNPI, but arriving at the same conclusion through analysis of public + nonmaterial nonpublic information is not. The Clement/Turgot Chariots example: salesperson interviews, union leaders, FX analysts, banking officials → "market underperform" conclusion. Mosaic theory protects this work. Document the mosaic. Keep evidence that the conclusion came from analysis, not a tip. When an analyst's own work becomes MNPI A well-known analyst's pending recommendation change can itself be material — the publication will move the market. This information is non-public until the analyst publishes. The Clement/Zito example: the financial journalist learning Clement's about-tobe-published view of Turgot Chariots, then trading on it and tipping family members, violated II(A). She didn't even know the underlying reasoning, but she knew the recommendation was about to be published and that publication would move the price. Analysts are not required to make their work public. The work, paid for by clients, has commercial value that legitimately accrues to those clients. Selective disclosure and corporate guidance A disclosure to a roomful of analysts is not public. Members must be careful that what feels like a "public" briefing is actually disseminated. Corporate guidance / interpretation given to analysts — be alert that you may be receiving MNPI when a company provides guidance or interpretation of public filings. Expert networks Permissible to use and pay for expert insights about industry conditions, technical issues, products, services. Members are responsible for not requesting or acting on confidential information received from external experts, even if the network's contracts purport to prevent MNPI exchange. Cannot rely on the agreement alone. Watson/semiconductor example: scientist disclosed disappointing test results that hadn't been made public; Watson relayed to fund, fund traded on it. Violation — Watson must make his own materiality determination, not rely on the network's compliance documents. McCoy/oncology consultations — using experts to enhance understanding of treatment landscape (without asking for or receiving preliminary trial results) is permissible. Tip handling Trading on an insider tip is a violation regardless of whether you make money. Kellogg/National Savings: assumed "Mayfield knows the law and wouldn't disclose inside info" — purchased shares on the basis of the tip, then lost money when other bad news hit. The fact of the loss does not absolve. Passing tips along is a violation, even if the recipient doesn't trade. Zito tipping her father about Clement's pending recommendation = violation regardless of whether her father acted. Trader-to-trader rumors are usually market noise. Nadler/text-message-from-traderfriend: a tip-message from a trader with no business relationship with the issuer is generally noise, not MNPI. The fact that a portfolio manager separately ordered the purchase makes the trade legitimate. Compliance practices for firms When MNPI is in the firm's possession: Try to achieve public dissemination by encouraging the issuer to release it. If not possible: restrict communication to compliance/supervisory personnel; do not trade; do not change recommendations. Firewalls: between investment banking/corporate finance and sales/research; between commercial lending and trust/research. An employee should be on only one side at any time. An analyst pulled into an investment banking deal becomes "wall-crossed" and cannot return to research until the information is public — and cannot use any of that information for research, nor share it with research colleagues. Watch lists / restricted lists / rumor lists for monitoring trading. Walking over the wall requires compliance officer coordination, not analyst-to-banker discussion. The Peter / Bright Ideas case — control failure Peter participates in a video conference about Bright Ideas earnings projections with investment bankers. Salespeople and PMs walk in and out of his office during the call and overhear the projections; some trade on it for clients and proprietary accounts. Peter violates II(A) for failing to control the information. Other firm members who traded also violate. This is a direct example of why firewalls and physical-information control are central. Traps and tells "Information disclosed at a meeting of the 10 largest shareholders" = nonpublic. "A roomful of analysts" = nonpublic. "My doctor mentioned..." = unreliable source → typically not material. "A senior executive friend said earnings will surprise" = material and nonpublic → trading is a violation regardless of the loss. "Trader friend texted me about strong earnings expected in two days" = noise unless the trader has a business relationship with the issuer. "He pieced together publicly reported information and conversations with industry contacts about non-confidential trends" = mosaic → permissible. "He learned of the well-known analyst's about-to-be-published recommendation" = the recommendation itself is MNPI. "She reached the conclusion through her own analysis of public and nonmaterial nonpublic information" = mosaic → permissible. "Expert provided trial results not yet released" = MNPI; cannot trade. "Office had walk-ins during a deal-sensitive call" = control failure → both the firm and any traders violate. II(B) Market Manipulation Conceptual structure Two categories: 1. Information-based manipulation — false/misleading statements (rumors, pump-anddump schemes, fake research). 2. Transaction-based manipulation — trades that distort prices or volumes (wash trades, cornering an instrument to manipulate a related derivative). Intent is the key Legitimate trading on perceived inefficiencies is not manipulation, even if it appears unusual in illiquid or volatile markets. The standard is whether the action distorts price/volume with the intent to mislead. Indicators (nonexhaustive list to recognize) Orders entered for unusually short time periods. Orders above market price. Orders that don't change beneficial ownership. Orders intended to move bid/offer that are canceled before execution. Orders on both sides using different platforms. Coordinated action by multiple traders in thin markets. Application patterns Issuer-paid promotion masquerading as independent research (FIS/microcap): the principal owner accepting compensation from microcap companies in exchange for "independent" research that is actually promotional → information-based manipulation. Violation. Spreading rumors plus trading through multiple accounts to inflate the appearance of liquidity (Gray/Fame Pharmaceuticals): dividing holdings into many accounts, creating an online rumor campaign, buying and selling between accounts to fake volume → both kinds of manipulation in one. Violation. Timing a research report to maximize damage during a quiet period (Murphy/Wirewolf): speculative content (unconfirmed CFO departure, EPS miss) timed to a period when the company can't respond → creating artificial price volatility → benefits firm's hedge fund short positions. Violation. This is "creating artificial price volatility designed to have a material impact on the price of an issuer's stock." Wash trading between two of your own funds (Sekar/Digital Design): moving DD stock between a balanced fund and equity fund to fake volume and lift the price → violation, even though the goal is to benefit fund participants. The end (helping clients) does not justify the means (fake volume). Inflating an earnings estimate to force company guidance (Gordon/Hygene): raising her estimate from $2.00 to $2.15 not because she believes it but to "force a comment" from the company while telling momentum-investing clients first → violation. Compare with the safe alternative: writing a report that frames earnings as a range with clear assumptions from her field research is permissible. Pump-and-dump in chatrooms (Weinberg/Moosehead & Belfast): spreading false rumors of expansion / new contracts to push prices on his own holdings → violation. Traps and tells "Created an online rumor campaign in addition to..." = information-based manipulation. "Trading between accounts in different brokerages to disguise..." = transaction-based manipulation. "Timing the report to a quiet period to maximize impact" = manipulation. "Floated an exaggerated estimate to force the company to clarify" = manipulation. "Recommendation framed as a range with disclosed assumptions" = legitimate. "For the benefit of fund participants" + wash trades = still manipulation; ends do not justify means. STANDARD III: DUTIES TO CLIENTS III(A) Loyalty, Prudence, and Care Conceptual nuances — the duty is not blanket fiduciary duty This is one of the most subtly framed standards in the handbook. III(A) does not impose a fiduciary duty on every member. It establishes a minimum benchmark of loyalty, prudence, and care; whether the member is a fiduciary depends on type of client, whether the member gives investment advice, and the surrounding facts. Members must comply with any legally imposed fiduciary duty. That comes from law, not from III(A) directly. Custody triggers a heightened standard. A member is considered to have custody if they have any direct or indirect access to client funds; managing assets in custody requires acting in accordance with the governing trust documents / IMAs. The standard's protections apply across roles: even an execution-only trader has a duty (best execution, working within client's instructions). The Sulejman example: a CFA candidate broker executing client-directed trades does not have a fiduciary duty under the Code, but does have a duty of skill and diligence to seek best execution within the client's parameters. Blended-environment members (advice + execution + limited product menu) must place client interests first within the constraints of the firm's offering and disclose those constraints upfront. Identifying the client — the most heavily tested aspect For pension plans / trusts: the client is the BENEFICIARIES, not the entity that hired the manager. First Country Bank / Wiley / Miller pension plan: when the company management asks the trustee to buy company stock to fend off a takeover (with the implicit promise of more business for the bank), the duty runs to the plan participants, not to Miller's management or to the bank's growth ambitions. For mutual funds / index-mandate funds: the duty is to invest consistent with the stated mandate. There is no individual client; client loyalty for fund investors is the responsibility of the advisors who put those investors into the fund. For an expert witness: the law firm is the employer, but the duty of independence governs the testimony. Hensley/expert-witness example: the law firm is bound up with the engagement, but Hensley's duty is to provide independent testimony — she cannot let the firm's interests color her opinion. For Spears/Miller (mutual fund case): Spears (the private wealth manager) owes the duty of loyalty to her individual client; Miller (the fund manager) owes his duty to the fund mandate — they do not "share" responsibility. The client, the fund manager, and the wealth manager each face different duties. Soft commissions / soft dollars Brokerage commissions are an asset of the client. When you direct trades to a broker, the resulting commission "belongs" to the client. Best execution and best price are required unless the client directs otherwise. Client-directed brokerage (the client tells you to use a specific broker) is permitted. Two duties apply: Confirm with the client that the goods/services obtained from that brokerage benefit the account beneficiaries. Disclose that the directed brokerage may not provide best execution. Using soft dollars to obtain research: acceptable only if the research benefits the client; the member cannot pay above-market commissions for goods/services that don't benefit the client. The Jackson/JNI/Thompson example: directing brokerage to a friend's firm whose execution is average and where commissions absorb JNI's overhead expenses (rent) → violation. Soft dollars cannot subsidize firm overhead. Five extra days of vacation in Rio paid by client commission dollars (Parker/SouthAM): even if the legitimate research portion of the trip is OK, the vacation portion has nothing to do with the investment decision-making process and cannot be paid with client commission dollars. Directing trades from Client B to a broker in exchange for the broker introducing new clients (Everett): disclosure is required, and best execution must still be sought. Directing trades without disclosing the motive to the existing clients = violation. Excessive trading / churning Knauss case: trading enough to hit the firm's commission floor. Even if individual trades are within suitable asset classes, the volume itself uses client assets to benefit the firm/member. Violation. Family accounts and conflicts of priority Family accounts that are normal fee-paying clients must be treated like any other client. Dill, who excluded his brother from an IPO allocation to "avoid the appearance of conflict," violated III(A) — the brother is a fee-paying client and is entitled to the same allocation as any other suitable client. The fix would be different if the brother's account were managed outside the normal fee structure. For accounts where the member has beneficial ownership (parent/spouse/account managed for own benefit), see VI(B): client priority requires the member's account to be last, not equal. Proxy voting Voting proxies is part of the duty. A cost-benefit analysis can show that voting all proxies is not beneficial to the client; in such cases, voting all is not required. Disclose the proxy voting policy. Failing to vote, voting blindly with management on non-routine governance issues, or voting without considering impact = violation. Performance reporting / firm-vs-client priority Nguyen example: a performance analyst who notices a missed trade that, when corrected, will produce a large loss for a client (who has put the firm on a "watch" list). Reporting it accurately, even though the client may terminate, is compliance — withholding material information is not in the client's interest. Governance documents and the "primary determinant" rule The trust document, IMA, or fund's governing documents are the primary determinant of the manager's powers and duties. Any action contrary to those documents puts the member at risk of violating III(A) (even if it would otherwise be reasonable). Traps and tells "Pension trustee buys company stock to fend off hostile takeover at the request of company management" = violates duty to beneficiaries. "The broker absorbs my firm's rent in exchange for trades" = soft dollars used for firm overhead → violation. "Used commission dollars to extend a research trip into Carnival vacation" = violation. "Excluded brother's fee-paying account from IPO allocation to avoid appearance of conflict" = violation (family is a client like any other). "Trades enough to meet firm's commission threshold" = churning. "Performance analyst caught an error that, when corrected, will hurt a key client's returns" → must report. "Client directed all trades to a specific broker" = permissible with disclosure that best execution may not be achieved. III(B) Fair Dealing Conceptual nuances "Fairly" not "equally." Members can never reach all clients at exactly the same time, and tailored services can be offered to clients paying for premium services. The differential-service exception has two strict conditions: (i) the different service levels must be disclosed to clients and prospects, and (ii) they must be available to anyone willing to pay — not offered selectively. Pre-dissemination conduct — a heavily tested zone Recommendation discussions before publication = violation. Ames had lunch with his best clients, mentioning a buy recommendation that would go out to all clients the following week → violation, even though the broader dissemination was scheduled. Limit the number of people who know about a pending recommendation before it is published. Shorten the time between decision and dissemination. If a detailed report takes weeks to publish, a short summary can be sent in advance to all clients. Aim for simultaneous dissemination. Once distribution has happened, individual followup calls to specific clients are permissible (Weng example). Dissemination through social media Burdette/Sun Drive: posting a "buy" recommendation on LinkedIn to followers (a select subset of clients) before firm-wide distribution = violation. The follow-up nuance: if the firm has formally distributed the recommendation widely, follow-up engagement with select clients is permitted (Weng's calls to his three largest institutional clients after sending the recommendation by email = compliant). Allocation of new issues / IPOs Block trade allocation principles: Pro rata across suitable accounts. Round-lot basis to avoid odd-lot distributions. Documented orders, time-stamped. First-in, first-out execution where appropriate. All accounts in a block trade get the same execution price and same commission. When the block isn't fully filled: pro rata allocation based on order size, with consideration of minimum lot sizes for some securities (e.g., bonds). For new issues: obtain advance indications of interest, allocate by client (not by portfolio manager), and document the calculation method. Member must forgo personal/family allocations when an issue is oversubscribed. Morris/PickleDilly: kept his own allocation while reducing institutional client blocks → violation. But: if family-member accounts are managed similarly to other client accounts, they cannot be excluded — they're treated like any other client (consistent with III(A)/Dill). Minimum-lot allocations The Hampton example is essential because it carves out an exception: Five clients want bonds. Three want $10,000 each, two want $50,000 each. Minimum lot is $5,000. Issue is oversubscribed, only $55,000 available. Hampton allocates $5,000 each to the three smaller orders and $20,000 each to the two larger orders. Because of the minimum lot size and bond market liquidity considerations, this allocation — not strictly pro rata — is permissible. The principle: pro rata, subject to minimum lot requirements that protect future liquidity. Trade-allocation manipulation Preston/PWI/Colby: failure to allocate trades immediately, then days later assigning profitable MBS trades to the at-risk client and losing trades to others = violation. The remedy is pre-trade allocation or systematic post-trade allocation. Selective disclosure Roberts/SIWM: repeating the public guidance of $1.16 EPS to all clients but informally telling large clients of an expected upside surprise = violation of III(B) (unequal disclosure of investment opinion). Selectively informing top clients of an opinion = violation, even if the publicly disseminated information is accurate. Cross-account misconduct Chan example: the manager intentionally over-trades other clients' accounts to generate brokerage commissions that fund research benefiting his father's pension plan → using one set of clients to subsidize another → violation. Jackson example (institutional commingled fund vs. discretionary pension fund vs. nondiscretionary pension fund): systematic priority for the commingled fund, with discretionary accounts above nondiscretionary accounts, with hot issues going only to the commingled fund → tiered priority structure that disadvantages whole categories of clients = violation. Differential service vs. preferential treatment Premium-fee clients may receive more in-depth service (Weng's calls to three largest clients). Compliant if (i) the recommendation reached all clients first, and (ii) premium service is generally available to anyone paying for it. Discussing a report with a select group before wide distribution = violation. Performance analysts as compliance enablers The Rove example: building reports that flag securities heavily held across accounts and outliers in monthly performance helps the firm verify equal treatment. Such reports support III(B) compliance. Client consent does not cure unfair allocation Even with full disclosure, a member's duty of fairness cannot be overridden by a client's consent to a patently unfair allocation procedure. This is buried in the guidance but tested. Traps and tells "Lunched with best clients before the report goes out" = violation. "Posted the recommendation on LinkedIn first" = violation. "Disseminated to all clients via email, then called the largest with detail" = compliance. "Filled the institutional block at the expense of clients" = violation. "Pro-rata except for minimum lot considerations" = compliance. "Allocated profitable trades to the at-risk client" = violation. "Hot issues go only to the firm's commingled fund" = violation. "Father's pension plan trades less; other clients pay for the research" = violation. III(C) Suitability Conceptual nuances The standard has two distinct provisions: (1) the advisory relationship suitability test, and (2) managing to a specific mandate. Suitability does not apply outside an advisory relationship. Sell-side analysts and pure trade-execution-only brokers do not have suitability obligations — they cannot judge suitability for the ultimate client. Suitability is judged in the context of the total portfolio. A high-risk investment can be suitable as a small allocation in a diversified portfolio, even if unsuitable on its own. The IPS is the operational document. Best practice is a written IPS at relationship inception, with at least annual reviews and ad-hoc updates upon material change. Members can only assess suitability based on what they're told. If clients withhold information about other holdings, the suitability analysis is necessarily based on the partial picture. IPS contents — what the handbook actually expects Client identification (type, beneficiaries, share of total assets you manage). Expectations: return objectives (income, growth, purchasing power) and risk tolerance. Constraints: liquidity needs, expected cash flows, investable funds, time horizon, tax considerations, regulatory/legal, investor preferences/prohibitions/unique needs (including ESG framework where applicable), and proxy voting responsibilities. Performance benchmarks. Updating the IPS — and when to push back Annual review at minimum, and prior to material recommendations or decisions. Material life changes trigger update: the Evans/Jones inheritance example (wealth quadrupled to US$1m) → review and potentially update IPS. Material market changes can also trigger more frequent review. Beneficiary preference changes (e.g., pension survey results showing ESG framework preference) trigger IPS amendment for institutional clients. Unsolicited trade requests This is a heavily tested gray area. The handbook gives a clear procedural sequence: 1. 2. 3. 4. Refrain from making the trade until you discuss the concerns with the client. Educate the client on how the request deviates from the IPS. Require client acknowledgment that the trade is against your advice. If the trade has a material impact on the portfolio, use the request as an opportunity to update the IPS so the client understands the effect on goals/risk levels. 5. If the client refuses to update the IPS while insisting on the trade, evaluate whether to continue the advisory relationship. Managing to a mandate A fund manager managing to a specific mandate must invest consistent with the mandate, regardless of attractive opportunities outside it. Perkowski/zero-dividend stock in a high-income fund → unless the fund's disclosed mandate accommodates it, this is a violation, even if the analysis is sound. Gubler/property-casualty insurance subsidiary IPS requires liquid investments → investing 4% in a private equity seed fund with three-year lockup violates the mandate, even though total equity exposure remains below cap. Snead/high-beta stocks in long-term retirement plans to chase quarterly performance bonuses → violates the IPS (and also crosses into VI(A) since the compensation arrangement creates the conflict). ESG and special preferences A client may include ESG criteria, prohibitions, or other preferences in the IPS. Once those preferences are formalized, all members in the chain must comply. The DeVries / Van Cleef / MPG pension example: the trustees' updated IPS includes a tobacco prohibition; an external manager who buys tobacco stock anyway because "investment return is my first priority" violates III(C). The trustee (DeVries) must ensure the external manager sells the inappropriate position. Selecting investments using ESG criteria is permitted as long as it serves the IPS objectives. The Kim/Park vs. Dong example: choosing the higher-ESG name when both are otherwise viable, on the basis that high-ESG companies have reduced regulatory and management risk, is consistent with suitability. Risk profile and total portfolio The Smith/Robertson/Lanai example: same allocation (20% in zero-yield small-cap hightech) is suitable for an aggressive 60-year-old with low income needs, not suitable for a 40year-old saving for children's education with steady-return objectives. Same investment, different clients, different answers. Covered call options on a risk-averse client's portfolio (McDowell/Crosby): suitable when the analysis considers the entire portfolio context and the client is fully educated on outcomes (added income, possible called-away tax liability, downside protection limits). Diversification Diversification is the norm for fiduciary-managed portfolios. An individual high-risk investment can be suitable in a diversified portfolio. A manager responsible for only part of the client's portfolio can only assess suitability based on what's provided. Traps and tells "The IPS calls for liquid investments. The new product has a three-year lockup but offers great returns." = violation. "The fund mandate is 'high-income.' She bought a zero-dividend stock she liked." = violation. "Compensation now rewards quarterly performance, so she changed strategy." = violation of III(C) and a VI(A) disclosure issue. "The pension survey supports an ESG framework, so the IPS now prohibits tobacco. The manager bought tobacco anyway." = violation. "Same 20% small-cap allocation applied to two clients with different ages and goals." = unsuitable for the conservative client. "Client insists on an unsolicited trade that breaches her IPS." = discuss, document, and possibly update IPS; if she refuses, consider ending the relationship. III(D) Performance Presentation Conceptual nuances The standard requires "reasonable efforts" toward fair, accurate, and complete performance information — not perfection. Applies to every claim about performance, not just GIPS-compliant firms or separate accounts. Includes pooled funds, individual recommendations, and research analyst track records. GIPS compliance is the safest path. If a firm claims GIPS compliance, it must comply fully — partial compliance with a claim of compliance is itself a violation (Judd/Alexander Capital case: composite returns weren't asset-weighted as required by GIPS, but the firm claimed compliance → violation by virtue of the false claim, not necessarily the underlying methodology). Brief presentations should reference the limited nature of the information and make the detailed support available on request. Specific tested patterns Single-year results presented as expected returns: Taylor Trust's 25% one-year return (matching the market) presented in marketing as "consistent 25% growth" when the average over five years was 5% → violation. The fix: clarify that the figure is one year's return on one specific fund, not a steady or expected rate. Performance from a prior firm: can be shown if accompanied by disclosure of where the performance was achieved and the member's role. McCoy/Mastermind's advertisement using six-year performance from G&P Financial without disclosing the source = violation. Simulated / back-tested returns: must be clearly identified as simulated. Davis/2000-2015 historical, 2016-2022 backtest → marketing the backtest period without disclosing it was simulated = violation. Cherry-picked composites: Kilmer's "balanced composite" that excludes accounts below an asset threshold (without disclosure) and includes accounts that don't have a balanced mandate (because they help returns) → violation. Manipulating the composition over time to optimize the appearance is also a violation. Excluding terminated accounts from performance history = a form of cherry-picking that misrepresents the manager's track record. Attribution methodology changes: Purell discovers that calculating attribution by industry rather than by sector improves how stock selection looks. Switching methodology without proper disclosure of the change = violation. Selecting between time-weighted and money-weighted returns to present whichever is more favorable (Singh's instructions): violation; clients need consistent methodology to evaluate performance. Compliance practices for non-GIPS firms The handbook provides a checklist for firms that don't claim GIPS compliance but need to meet III(D): Consider audience knowledge / sophistication and tailor accordingly. Present composite performance, not single-account performance. Include terminated accounts in composite history. Disclose: simulated nature when relevant, prior-entity performance when relevant, gross/net of fees, after-tax status. Maintain calculation records. Traps and tells "25% growth" repeating last year's return as if typical = violation. "Used the model retroactively to 2016-2022 to demonstrate the strategy" without disclosing simulation = violation. "Composite excludes terminated accounts" = violation. "Composite excludes accounts below $X" without disclosure = violation. "Picked the methodology that produced the highest return" = violation. "Performance from prior firm shown without source" = violation. "Claims GIPS compliance" + does not asset-weight = violation (the false claim is the violation). III(E) Preservation of Confidentiality Conceptual nuances — scope and exceptions Three exceptions: illegal activity by the client; disclosure required by law; client (or prospective client) permission. Applies to current, former, and prospective clients. Confidentiality survives the end of the relationship. The standard is triggered when: (i) you receive information because of your special ability to handle the client's business or affairs, and (ii) the information arises from or is relevant to that business that is the subject of the special relationship. You're not required to be an IT security expert. You must understand and follow firm policies for electronic information. Cooperation with CFA Institute Professional Conduct (PC) investigations is required, unless prevented by law. III(E) does not shield non-cooperation. Vulnerable investors — best practice Establish a secondary contact at the start of every account relationship. This creates a permission-based path to consult someone (a family member, legal adviser, or trusted intermediary) if the client's mental capacity declines. Without a pre-arranged secondary contact, III(E) prohibits discussing the client's situation with anyone except authorized fellow employees — even with good intent. Government / regulatory channels may exist for intervention; following applicable law on permitted disclosures does not violate III(E). Documentation is critical. All conversations with the client and any third parties about disclosures must be documented and retained. When can you disclose? Required by law / subpoena / regulator (e.g., government's request for pension fund records — Samuel/Garcia case): consult counsel; you may have a duty to provide records. Possible illegal activity by the client (e.g., CFO embezzling — Bradford case): check with compliance / legal counsel about whether disclosure is required by securities regulations. Client permission: explicit authorization to disclose. Cases where disclosure is not allowed despite good intent Moody/Lester Trust: Moody's client mentions making a $50,000 charitable donation. Moody is also treasurer of "Home for Indigent Widows" and recommends HIW's VP for corporate gifts call on her client. Violation — the client's financial decisions are confidential; intention is irrelevant. Connor/City Medical Center: the trustees gave Connor internal reports about plant renovation needs to inform her endowment management. A local businessman wants the renovation plans before deciding which hospital to donate to. Connor cannot disclose; the information is within the scope of the confidential relationship. Vulnerable-investor cases — pattern recognition Gonzales / Brennan (widow with declining acuity): Gonzales had pre-arranged with Brennan that her son would be the secondary contact. Documented signs of cognitive decline (forgotten meetings, confusion about long-established objectives, irritability). When Brennan suddenly directed liquidation of 50% of her portfolio to fund a speculative investment by her physical therapist, Gonzales documented and contacted the son. Compliance — pre-existing permission + objective concern + documentation. Smith-Pelley / Carlson (widow remarried abroad to younger man): No pre-existing secondary contact. Carlson's adult children from her first marriage demand the accounts be frozen, claiming she is being taken advantage of. Smith-Pelley refuses and continues to follow Carlson's directions. Compliance — sudden / unexpected decisions are not the same as diminished capacity, and there is no agreed secondary contact path. He is right to keep her information confidential and follow her instructions. The contrast is sharp: the secondary contact is what enables Gonzales's intervention; without it, Smith-Pelley cannot act. Accidental disclosure Moody (LTC social media group): a client posts highly personal information on the group page. Moody had warned clients not to post confidential information on the platform; she promptly removes the post. Compliance — she took reasonable steps, the disclosure was the client's, and she remediated. Traps and tells "The well-intentioned charitable referral to a wealthy client" = violation. "Sharing the client's plans with a friend who is choosing whom to donate to" = violation. "Pre-existing secondary contact + documented decline + sudden out-of-character decision" = permitted disclosure to that contact. "Adult children demanding account freeze without any pre-existing arrangement and without clear evidence of incapacity" = continue following client's instructions; do not disclose. "Government investigation requesting pension records" = consult counsel; may need to disclose. "CFO of a client appears to be embezzling" = consult compliance/legal counsel about reporting duty. "Refusing to cooperate with a CFA Institute PC investigation by claiming III(E)" = not permitted. STANDARD IV: DUTIES TO EMPLOYERS IV(A) Loyalty Conceptual nuances — what loyalty actually requires The standard does not put employer interests ahead of personal/family interests in all matters. Personal and family obligations are not subordinated; the duty is to engage in dialogue with the employer when these conflict with work on a regular or significant basis. The standard does not preclude independent business activity while employed — but you cannot provide services that compete with your employer's offerings without explicit consent. You must notify, describe (services, duration, compensation), and receive consent before rendering services. The employer–employee relationship ends when you stop being paid or stop having responsibilities — the resignation letter alone doesn't end it. During any notice period, full duty of loyalty continues. What you can prepare for vs. what you cannot do The handbook draws a sharp line between preparation and competition / solicitation. Permitted while still employed: Registering with regulators to start a competing business (Allen example) — provided the work is on personal time and the new entity does not solicit clients or operate yet. Building general arrangements for a future business. Updating your LinkedIn profile to a new employer after departure — the auto-notification to your network is not solicitation (Webb example). Prohibited while still employed: Soliciting current clients or prospective clients for the new firm (Magee/Trust Assets/Fiduciary). Misusing confidential information. Self-dealing. Using firm property without permission. Disparaging the current employer to clients. Discussing a change of employment in a way that disparages the current firm. Promoting the new employer to current firm's clients without permission. Responding to an RFP that the current firm is also responding to (Example 7) — this is direct competition, prohibited without the employer's permission. Information you can take vs. information you cannot A critical distinction: Skills, experience, knowledge acquired on the job — these are not confidential. You may use them at a new employer. Names and existence of former clients (in your memory, from public sources) — generally not confidential, unless an agreement says otherwise. You may contact former clients after departure using public information. Client lists, account statements, marketing presentations, recommended-securities lists, computer models, spreadsheets, work product — these belong to the employer. You cannot take them, even those you personally created. Hightower is not allowed to take any of items 1–7 in his case — even the spreadsheets he developed himself. Records on your personal devices (phones, tablets, laptops) used for convenience must be returned or erased unless the firm permits otherwise. Solicitation rules around departure After providing notice of intent to resign, you may inform the clients you work with that you are leaving and going to a new firm — but you must not communicate in a way that explicitly or implicitly solicits clients or business for the new employer. Specifically: you may give the new employer's name, but you cannot give your contact info at the new firm without the current employer's permission, you cannot describe the new firm's services, and you cannot otherwise promote the new employer. Disparaging the current employer to clients = solicitation by another route. Even if true and even if the client would be better off elsewhere, disparaging during your remaining employment is a violation. Promoting the new firm "in the name of protecting the interests of clients" is not permitted while still employed. The fix: resign first, then communicate with clients. Once you have left, you may contact clients using public information about them, in the absence of a contractual restriction. Independent contractor relationships A member's duties as an independent contractor are governed by the oral or written agreement with the client. Members must clearly define the scope of responsibilities and expectations. Once the relationship is established, the duty is to abide by the terms of the agreement. Whistle-blowing — narrow exception Acting against the employer is permitted only if intent is to protect clients or market integrity, not for personal gain. The Nash/regional advisory firm example shows the contrast: Nash properly raises concerns internally up the chain. After resigning, when a client contacts him for the reason, telling the client about the unethical practices and soliciting her to follow him to his new firm = violation. Even when whistle-blowing is justified, you cannot piggyback on it to solicit clients. Intern and unpaid scenarios An unpaid intern is still considered an employee for purposes of IV(A) — Madeline (intern at Murdoch and Lowell) using firm software at her new full-time employer = violation. Compensation includes "work experience and knowledge." Personal blogs and social media Gupta/Naram example: writing a personal blog with views that contradict (and indirectly disclose) the firm's password-protected investment recommendations = using firm resources for personal advantage and disclosing confidential firm information → violation. Best practice: keep separate accounts for personal and professional social media activities, and clarify with the firm before departure how to address client connections in your social media networks. Traps and tells "Solicited several big accounts to leave Trust Assets before resigning" = violation. "Took the client list, even spreadsheets he created" = violation. "Started preparing the new business by registering with regulators" without soliciting = compliance. "Updated LinkedIn after the departure" = compliance; auto-notification not solicitation. "Disparaged the current firm to a client" = violation. "After leaving, contacted former clients using public information" = compliance (subject to contractual restrictions). "Personally created the spreadsheet, so I can take it" = violation; firm property regardless of who built it. "Responded to an RFP my current firm also responded to" = violation without permission. "Wrote a personal blog with my own views on stocks the firm covered, disclosing the firm's positions indirectly" = violation. IV(B) Additional Compensation Arrangements Conceptual nuances All parties' written consent. "Written consent" includes any documentable communication — email is acceptable. The disclosure should include nature of compensation, approximate amount, and duration. The party offering the compensation should acknowledge and confirm the disclosure. Includes nonmonetary benefits. Free gym memberships (Jones/Exercise Unlimited), board service compensation in any form, free travel — all need disclosure. The standard exists because additional compensation may affect loyalties and create conflicts of interest. Even if you believe it won't influence you, the employer is entitled to assess the situation independently. Application patterns Whitman/Cochran/Adams Trust Company: a client offers Monaco trip and condo if the portfolio achieves 15% pre-tax. Whitman doesn't tell the employer. Violation — the contingent compensation arrangement could create partiality to Cochran's account at the expense of other clients. The fix: disclose to the employer in writing before accepting. Jones/Clarksville/Exercise Unlimited: unlimited family gym privileges in exchange for serving on the board, while also recommending the company's stock for client accounts. Even though no monetary compensation, the benefit creates a conflict. Violation for failing to disclose. Hollis/Specialty Investment Management/ABC Oil: invited to ABC's headquarters. Hollis (i) gets prior approval for the meeting, (ii) declines the offered air travel and accommodations, (iii) attends an upscale dinner with the CEO and IR officer, and (iv) discloses the dinner upon return. Compliance — the structure of pre-approval and postdisclosure works. Traps and tells "Performance bonus from a single client paid directly to the manager" = needs employer's prior written consent. "Free gym memberships in exchange for board service" = nonmonetary benefit; needs disclosure. "Did not inform employer because no money was paid" = violation; the principle covers nonmonetary benefits. "Got prior approval; declined the corporate jet; disclosed the dinner" = compliance. "Jones serves as director and recommends the stock" = even with disclosure, the conflict still has to be evaluated; nondisclosure is the immediate issue but the conflict is the broader issue (also VI(A) territory). IV(C) Responsibilities of Supervisors Conceptual nuances Anyone with employees under their control or influence has supervisory responsibility, regardless of whether the employees are CFA charterholders, members, or candidates. Reasonable supervision depends on the number of employees and the nature of the work; supervision can be delegated to subordinates with instruction about preventing and detecting violations. The supervisor's task is system-building, not personal monitoring — establish the compliance system, then ensure it's monitored and enforced. A code of ethics is not enough. It must be implemented through specific compliance policies and procedures. Codes of ethics should be separate from compliance procedures. Codes are principlebased and accessible. Compliance procedures are detailed, firm-specific, technical. Mingling them dilutes both. Adequate compliance system The handbook lists what "adequate" compliance procedures look like: Clearly written, accessible, tailored to the firm. Easy to understand. Designate a compliance officer with authority and resources. Describe supervisory hierarchy and assign duties. Implement checks and balances. Cover monitoring and testing. Detail permissible conduct. Delineate violation reporting and sanctions. What a supervisor must do once a violation is discovered Promptly initiate an assessment of the wrongdoing's extent. Reliance on the employee's self-statement is not enough. Reporting it to compliance/management and warning the employee is not enough. Take steps so the violation cannot be repeated: increased monitoring, limits on employee activity, until the investigation concludes. When the supervisor cannot supervise Bring inadequate compliance to senior management's attention with a proposal for corrective action. If the supervisor cannot adequately supervise (because the firm refuses to fix the system), decline to accept supervisory responsibility until reasonable procedures are in place. Patterns from the application examples Mattock/H&V/Timber Products: changes recommendation from buy to sell; orally advises executives before publication; fails to implement procedures to prevent dissemination/trading by those informed. Frampton trades for himself and discretionary clients; others tip institutional clients. Mattock's failure as a supervisor — even though she did inform colleagues per firm procedure — is not implementing procedures to control downstream behavior. Violation. Mason/Wheeler & Company: trainee Edwards uses anticipated profits to pay for purchases, in a stock not on the firm's recommended list. Large trading volume in this manner. Mason notices and does nothing. Compounding factor: her compensation is tied to the trading department's commission revenues. Violation — supervisors must be especially sensitive to conflicts between their own self-interest and supervisory duties. Tabbing/Crozet/S&P futures and Claudius: Tabbing places futures orders without designating accounts up front, then assigns favorable executions to the employee profitsharing plan and unfavorable to the public funds. The firm has no written futures-trading procedures. Claudius (the president) violates IV(C) by failing to establish recordkeeping/reporting procedures and to supervise. Rasmussen/Blair/Saunders: Rasmussen, a buy-side trader on a hedge fund desk, notices that fund-reported performance doesn't reflect the obvious mark-to-market drop in underlying securities. She raises concerns to her supervisor (Blair) and the firm's compliance officer (Saunders); both tell her to drop it. Both Blair and Saunders violate IV(C) — supervisors and compliance officers have a duty to investigate concerns, not dismiss them. Burdette/FIM/Graf: Burdette, encouraged to expand the firm's social media presence, posts a "buy" recommendation on LinkedIn before firm distribution. Graf has not established social media policies. Graf violates IV(C) for failing to establish reasonable procedures to prevent unauthorized social media research dissemination. Bartlett/Sokol/Final Frontier Wealth Management: Sokol recommends a complex Feeder Fund to over 100 clients, including conservative-profile clients, without proper suitability assessment. Bartlett (compliance officer) violates IV(C) — inadequate policies, procedures, training, and supervision allowed Sokol's misconduct. Bartolucci/D'Addario/BOAC and Amity Point: D'Addario provides inflated price quotes to a customer (Amity Point) in exchange for trade flow; Amity Point uses these quotes to inflate fund NAVs. Bartolucci, as CEO and direct supervisor, knew of the price-quote business and failed to develop policies governing it. Violation — the absence of policies in a known risk area is itself a supervisory failure. Traps and tells "Reported the violation to compliance and warned the employee" is not enough — the supervisor must also investigate, monitor, and limit. "The compliance officer dismissed the concerns" = the compliance officer is also violating IV(C). "The president knew price quotes were being given to clients but never developed any policy" = supervisory failure even without direct involvement. "Encouraged social media outreach without setting policy first" = supervisory failure. "Compensation tied to the same activity being supervised" = supervisor must be especially sensitive to the conflict. "Tabbing did the misconduct; Claudius (the president) failed to set up procedures" = both violate, but for different reasons. STANDARD V: INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS V(A) Diligence and Reasonable Basis Conceptual nuances The required level of diligence depends on the member's role, the firm's investment philosophy, and the resources available. There is no one-size-fits-all standard. A bad outcome is not by itself a V(A) violation. Newbury's hedge fund (Top Shelf) lost 60% after appropriate due diligence; not a violation. Investment recommendations carry downside risk. Loss without diligence vs. loss with diligence is the key distinction throughout the examples. Reliance on third-party / secondary research Third-party research = research from outside the firm. Secondary research = research conducted by someone else inside the firm. A member can rely on third-party / secondary research only if they make reasonable efforts to determine that the research is sound. Criteria to assess: assumptions used; rigor; date / timeliness; objectivity and independence. If you have reason to suspect the research is biased, unreliable, or deficient, you must not rely on it. A portfolio manager who doesn't choose the data vendor (firm-chosen) can rely in good faith assuming the firm's due-diligence process was adequate. Quantitative models — special diligence Members must understand parameters, assumptions, and limitations — not the technical implementation details. Model creators must do more diligence than model users. Heightened review for new products before distribution. Test outputs before incorporating a model into the decision process. The model must capture a wide range of inputs, including stress / negative scenarios that may lie outside the historical database. Thompson's worst-case housing-price-appreciation scenario (–10%, –5%, 0%) when no negative HPA had ever appeared in the database is compliant — going beyond observable history when conditions warrant. Liakos/Hellenica/Carapalis: modeling group outsources components of a derivative strategy; each component is individually validated, but the integrated whole is never tested. The integrated strategy fails dramatically. Violation — when a strategy is intended to be implemented as a whole, the integration must also be validated. Cannon/CityCenter: incorporating a blog's research factors into the firm's proprietary models without independent testing → violation. The blog can be a source of ideas; testing is the analyst's responsibility. Reichardt + Dupont/XYZ Asset Management: Reichardt manages money based on a model he doesn't understand. Dupont neglects updates and patches the model with limited new data. Both violate — Dupont for the inadequate testing/maintenance, Reichardt for using a model without understanding its parameters and limitations. External advisers / subadvisers Selection requires due diligence comparable to selecting individual investments. Criteria include: code of ethics, compliance and internal controls, quality of return information, investment process and adherence to stated strategy. Industry standards and codes can be used as criteria — Asset Manager Code, GIPS, Model RFP. Selection on cost alone is not enough. Ostrowski's selection of the lowest-fee subadviser for international equity, after sending out a Model RFP and receiving seven responses → violation; cost is one factor among many. Jackson/Armaniams Partners: considering only performance and GIPS compliance for hedge fund subadviser selection → violation; thorough investigation required. Stefansson/Arctic Global Advisers: recommending a performance attribution system based only on a memorable booth conversation, without reviewing four other systems or determining whether the attribution process aligns with the firm's investment practices → violation. Group research / committee process You can leave your name on a group report you don't fully agree with, as long as the consensus has a reasonable and adequate basis and is independent and objective. You may request your name be removed (Mastakis example), but you don't have to dissociate if the process produced reasonable results. This is unusual: V(A) gives a path to remain associated with a report whose conclusion isn't yours, provided the process is sound. Updates to recommendations Material changes to a recommendation's underlying facts (e.g., the loss of CIO and most of the equity team at a recommended subadviser, between report draft and delivery) require updating the report. Failing to update = violation (Chandler example). Sufficient due diligence and the time-pressure trap Hawke/Sarkozi Securities: time pressure to price IPOs before a tax loophole closes; bypasses individual research and prices by relative size, planning to justify later. Violation — time pressure does not reduce the required diligence. Traps and tells "Categorized issuers by general size to estimate IPO prices, planning to justify later" = violation. "Recommended a subadviser with the highest total returns and shortest turnaround" = insufficient diligence. "Selected the lowest-fee subadviser to preserve the firm's bottom line" = insufficient diligence. "Components individually validated; not tested as integrated strategy" = violation when intended as integrated strategy. "Took ideas from a blog and incorporated them into the model without independent testing" = violation. "Used the model without understanding its parameters" = violation. "Stress-tested with assumptions outside the historical database" = compliance. "Relied on the firm-chosen data vendor in good faith" = compliance, assuming the firm's vetting was adequate. "Mastakis disagreed with the committee's revised conclusion but the process was sound" = name removal allowed; dissociation not required. "Newbury's hedge fund lost 60% after thorough vetting" = not a violation. V(B) Communication with Clients (REVISED in 12th edition) What's new in the 12th edition The 2023 revision added a new requirement to disclose the nature of services provided AND the costs to the client associated with those services. Previously the standard covered investment-process disclosure but not service/cost disclosure. This is heavily flagged as a likely Level II testing area. Conceptual nuances Communication is broad — written reports, verbal recommendations, electronic communications, social media, broadcast media. Even a one-word "buy" or "sell" can be a recommendation under the standard. Disclosure must be ongoing, not just at the start. Changes in services or costs trigger updates. Cost disclosure includes affiliate, related-entity, and third-party costs in providing services. Member cannot rely on the sophistication of clients to skip this. Specific dollar amounts are not required when the fee is determined by formulas (e.g., AUM-based quarterly fees) — but enough detail to understand the cost is required. Information can be tailored to the knowledge and sophistication of each client. Generally affects only client-facing members. Members without client-facing responsibilities don't have a duty to ensure client disclosures, although CFA Institute encourages all to help. Elements that must be communicated about the investment process Basic format and general principles. Material changes that might affect those processes. Significant risks and limitations (including liquidity and capacity). Use of external advisers / subadvisers. Distinction between fact and opinion. Risks and limitations — what counts Market-related risks and risks from complex instruments. Counterparty, country, sector, security-specific, credit risk. Leverage = significant risk; must be disclosed. Liquidity and capacity are both limitations: Liquidity = ability to liquidate timely at reasonable cost. Capacity = the investment amount beyond which returns will be negatively affected by new investments. Disclose risks known at the time of disclosure. Risks unknown at the time may reveal a diligence problem (V(A)) but not a V(B) violation. Fact vs. opinion Earnings estimates, dividend outlook changes, future market price information are opinions, not facts. Quantitative analysis output is also opinion (e.g., Dox's 500,000-ounce gold reserve calculation based on core samples is a quantitative opinion, not a fact). Statistical projections must come with disclosure of limits. Promote model accuracy with caution — model output is an estimate, not a certainty. Material changes that trigger client notification Lifting the small-cap ceiling from $2bn to $8bn = material change in the investment process (May & Associates / Clio). Adding non-US small caps to a previously US-only universe = material change. Adding a new and different valuation model (e.g., dividend discount replacing P/E) that depends on forecasting skills the firm previously didn't use = material change (Rodriguez/RJZ Capital). Stock selection responsibility moving from individual analysts to a committee = material change (Morales/Fundamental Asset Management). Outsourcing a portion of the management to external managers = material change requiring disclosure (Chinn/Diversified Asset Management — example of compliance). Refinements that don't fundamentally change the process don't necessarily trigger notification, but the line is drawn at "significant" / "material" changes. Cost-disclosure patterns Alphonso/ABC Capital Private Equity Fund III: the firm charges structuring fees to portfolio companies, retains the fees if the investment increases in value, remits to the fund if value decreases. Not disclosed in the PPM. Violation — even though the arrangement benefits investors when investments decrease, and even though it is "common industry practice," the compensation must be disclosed. Member cannot rely on client sophistication. Maalouf: firm transitions advisory fee calculation methodology — from average daily balance to end-of-billing-cycle market value, and now including cash and cash equivalents previously excluded. Firm did not communicate the change. Violation — methodology changes must be disclosed even if they may result in lower fees in some cases. Jones/manager-search example: uniform comparison of manager services with same time periods, same benchmarks, gross-of-fees presentation, fees charged + total fee paid + additional fees explanation. Compliance — proper cost disclosure for a manager search. Investment process disclosure — sufficiency Williamson/Country Technicians: plans a newsletter that gives only top "buy"/"sell" recommendations, leaving out details of the valuation models and portfolio construction rules. Violation — clients must understand the basic process to evaluate limitations and risks. Thomas/Government Brokers, Inc.: structured product designed to benefit from declining rates; report indicates high returns "if various scenarios for declining rates are assumed" but doesn't explain how the firm offers such returns, doesn't address scenarios where rates rise, doesn't disclose related risks. Violation — must include balanced discussion of scenarios, leverage, and liquidity. Yakovlev/QSC Capital small-cap strategy: $3bn capacity threshold (beyond which returns will be negatively affected) is known but not disclosed because the fund only has $100m. The marketing manager (Wellard) wants to focus on track record. Violation — capacity is a significant limitation; disclosure is required even though the threshold is far away. Ramon/Brickell Advisers: describes VaR analysis as "extremely effective" without disclosing inputs, methodology, or potential limitations. Violation — VaR-predicted losses depend on inputs; size and probability of losses can differ substantially from the model. Manner of disclosure Best practice is written. If firm-mandated disclosures are inadequate, alert the firm; supplement them where possible. If you cannot fix or supplement, document objections and dissociate from the activity. Traps and tells "Common industry practice, no disclosure required" = violation; common practice is not a defense. "Sophisticated clients should know already" = violation; cannot rely on sophistication. "Methodology change resulted in lower fees, so no disclosure" = violation. "Lifted the market-cap ceiling from $2bn to $8bn and notified prospects" = must also notify existing clients. "Replacing trailing P/E with dividend discount model" = material change requiring notification. "Stock selection responsibility moved from analysts to a committee" = material change. "Capacity threshold of $3bn but the fund is at $100m" = must still disclose. "VaR analysis described as 'extremely effective'" without inputs/limitations = violation. "Earnings estimate stated as fact" = violation; opinion must be distinguished. "Dox calculated 500,000 oz of gold from core samples; recommends strong buy 'based on the fact that the company has 500,000 oz of gold'" = the calculation is opinion, not fact; violation. V(C) Record Retention Conceptual nuances Retention applies even to decisions to do nothing. Reviews that don't lead to a position change still need supporting records. Records that count: personal notes, press releases, computer model outputs and inputs, risk analyses, selection criteria for external advisers, meeting notes (with companies and clients), outside research reports, and electronic communications (emails, texts, blog posts, social media posts). Records belong to the firm. A member cannot take original or copy records to a new employer without express consent. Reproduction of historical recommendations / research at a new firm is permitted only if the supporting documentation is recreated at the new firm, using new sources (not the original employer's materials). In the absence of regulatory or firm requirements, CFA Institute recommends at least 7 years retention. Responsibility primarily rests with the firm but members should still archive their work. Application patterns Lindstrom/IPS retention: when a client complains about a 35% technology allocation in his benchmark-tracked portfolio, having the IPS, the dated records of investment-process explanations, and regular IPS updates is what supports compliance. Compliance. Young/luxury retail research: must keep copies of all the source materials used in his reports — interviews, on-site visit notes, customer surveys, secondary research from related-industry analysts. Failure to maintain = violation. Blank/Buku Investment Management: developed an analytical model, documented assumptions and reasoning. Now hired by a competitor and takes copies of the records to support the model at the new firm. Violation — records belong to Buku. Blank must recreate the records at the new firm using new (independent) sources. Traps and tells "Took the records that supported his model to the new employer" = violation. "Recreate the model and the records using only new sources at the new firm" = compliance. "Did not retain notes from interviews, on-site visits, and surveys" = violation if the report was based on them. "Reviewed the position but kept no record of why no change was made" = violation; reviews need records too. STANDARD VI: CONFLICTS OF INTEREST VI(A) Avoid or Disclose Conflicts (REVISED in 12th edition) What's new in the 12th edition The 2023 revision renamed the standard to "Avoid or Disclose Conflicts" and added the requirement that members avoid conflicts when reasonably possible — not just disclose them. Disclosure remains the fallback when avoidance isn't reasonable. The historical guidance had long called avoidance "best practice"; now it's part of the standard's text. The disclosure requirements Prominent — placed where it can be easily seen, not buried in footnotes or appendices. Plain language — clear, common words, not jargon. Effective communication — tailored so the recipient actually understands. Updates when the conflict materially changes (e.g., compensation structure changes from annual to quarterly bonuses). What a "conflict of interest" includes A conflict of interest is "any matter that could reasonably be expected to impair independence and objectivity or raise a question about whether actions, judgment, or decision making is free from bias." Notice the breadth — actual impairment isn't required. Common categories: Compensation structure (especially incentive/bonus structures focused on short-term performance). Stock ownership in companies covered (the most prevalent conflict). Family-member ownership. Personal relationships with managers / decision-makers. Investment banking relationships. Underwriting / financial relationships. Broker/dealer market-making activities. Material beneficial ownership. Service as a board member or director. Cross-departmental conflicts (sell-side analyst pressured to favor companies; buy-side underwriting tensions; marketing pressure). Subadvisory and fee-structure arrangements. Rebates of mutual fund service fees. Beneficial ownership For purposes of VI(A), beneficial ownership exists when a person has: Direct or indirect pecuniary interest in the security, OR Power to vote / direct voting of the shares, OR Power to dispose / direct disposition of the security. This is broad — extending to family members, trusts, etc. Service as a board member / director — three-way conflict The handbook calls out three distinct conflicts: 1. Duties owed to clients vs. duties owed to shareholders of the company. 2. Compensation in securities or options of the company can be perceived as motivating actions to increase the security's value. 3. Material nonpublic information access — even when kept confidential, the perception of leak is itself a problem. The remedy: investment personnel serving as directors should be isolated from those making investment decisions by firewalls or similar restrictions. Avoidance vs. disclosure — pattern recognition The handbook articulates a hierarchy: avoid > mitigate + disclose > disclose. Examples where the handbook prefers avoidance: Hobbs / Dover & Roe / First of New York: after Dover & Roe sells a 25% partnership stake to First of New York, Hobbs immediately changes her recommendation on First of New York from sell to buy. Best practice: discontinue research coverage (avoid). At minimum: disclose to all clients and require portfolio managers to disclose ownership when making First of New York recommendations. Fargmon / Kincaid Printing: wife inherits $3m of Kincaid stock. Best practice: ask the employer to assign another analyst to the follow-up report (avoid). At minimum: disclose to employer and in the follow-up report. Roberts / Drew Mining (penny stock): held shares speculatively; asked to write a report on penny mining stocks. Best practice: decline the assignment. If she writes the report anyway, must disclose the conflict to her employer and in the report. Carter / Bengal International / Badger: stock promoter offers additional compensation for sales of Badger stock. Best practice: decline (avoid). At minimum: disclose to employer and clients. Compensation arrangements as conflicts Snead/Thomas Investment Counsel: quarterly performance bonus changes the manager's behavior (high-beta stocks for long-term retirement portfolios). The compensation arrangement creates a conflict that must be disclosed to clients — but importantly, the changed strategy that violates the IPS is also a III(C) suitability problem. The compensation conflict didn't cure the strategy mismatch. Carter (above): additional compensation from the issuer for selling its stock = both conflict of interest and pressure on objectivity. Disclosure helps clients evaluate; avoidance is preferred. Personal relationships Papis/Nagle/Accessible Real Estate: the CIO of a state retirement fund changes external real estate manager from a long-tenured adequate-but-unremarkable manager to his old business school classmate's new firm. The personal relationship was not disclosed to the employer. Violation — the disclosure would have allowed the firm to evaluate the impairment. Cross-department / business-relationship conflicts Weiss/Williamsburg/Jimco: Weiss is writing a research report on Jimco; his firm has been Jimco's M&A advisor for 20 years and Williamsburg officers sit on Jimco subsidiary boards. Disclosure required — broker/dealer involvement in public offerings and the special past/future relationship threaten objectivity. Traps and tells "Compensation tied to the conclusions of the research" = avoid; cannot save by disclosure. "Compensation tied to performance of accounts under management" = disclose; potential I(B)/III(C)/VI(A) issues if it changes behavior. "Wife inherited stock in covered company" = best practice avoid (reassign); minimum disclose. "Personally owns penny stock and writing a report on penny stocks" = decline / disclose. "Old business school classmate's firm" = disclose to employer. "Spouse of a senior officer at the issuer" = disclose. "Disclosed in a footnote in tiny font on page 184" = not prominent; violates new requirement. VI(B) Priority of Transactions Conceptual nuances Hierarchy: clients > employer > member's personal accounts. Co-investing with clients is not inherently a conflict. Some investment situations require aligned interests (e.g., partnership models). The standard targets situations where the member's transaction adversely affects the client's interests. Three-prong test for permissible personal transactions: 1. Client is not disadvantaged by the trade. 2. Member doesn't personally benefit from trades undertaken for clients. 3. Member complies with applicable regulatory requirements. Sometimes personal trades may run counter to client recommendations. A member may need to sell an asset for personal financial reasons even if the firm is recommending purchase. This is permissible if the personal trade doesn't disadvantage clients. Beneficial ownership for purposes of VI(B) Member's own account. Accounts of immediate family members. Accounts in which the member has a direct or indirect financial interest. Family-member accounts that are client accounts are treated like any other firm account — not given special treatment, not disadvantaged. Compliance practices firms typically adopt Limited or no participation in IPOs: The hot-issue concern: members' participation may appear to take an attractive opportunity from clients. The deal-flow concern: IPO allocations may appear to be incentives for future business. When permitted, members should preclear participation, and the standard avoids benefiting from "the position that their clients occupy in the marketplace." Restrictions on private placements: similar conflict-of-interest issues as IPOs; firms may prohibit. Blackout / restricted periods: prevent front-running. Investment personnel involved in decision-making must wait until clients have had opportunity to act. Reporting requirements: Disclosure of holdings with beneficial interest (start and periodically). Duplicate confirmations of transactions to the firm — independent verification + cash-flow verification. Preclearance of personal trades. Application patterns Long/research analyst: intentionally avoids recommending a stock to the employer's pension account in order to buy it personally first. Violation — taking advantage of knowledge before the employer benefits. Baker/aggressive growth mutual fund: routes hot-issue allocations to her husband's brokerage accounts (which are not client accounts at her firm). Violation — must allocate to fund first; even if husband's account were a client of the firm, she would still need to disclose the trading and create the conflict structure. Toffler/Esposito Investments: parents' retirement account, manages on a fee-paying basis. Toffler allocates IPOs to other clients first, then her parents' account, "to avoid favoring family." Violation — fee-paying clients are entitled to the same treatment regardless of relationship. (Note the symmetry with III(A)/Dill: family clients can't be disadvantaged either.) If Toffler herself has beneficial ownership in her parents' account, then preclearance and reporting requirements may apply. Michaels/George: Michaels is an entry-level employee in research and investment management; bought stocks just before they were placed on the firm's "buy" list. Routinely declined to file the firm's quarterly personal transaction form. Violation by Michaels (front-running clients). George (the supervisor) violates IV(C) for not requiring Michaels to complete the form. Riley/Wilson/insurance analyst: Wilson presents internally a negative view on an insurance company; Riley (head of trading) closes long calls and establishes a put position seven minutes later, ahead of the published report. Violation by Riley — she traded for the firm's own account before clients could receive the recommendation; even if her motive was facilitating future client sales, she should have waited for clients to absorb the recommendation. Traps and tells "Personal account purchase before recommending the stock to the employer" = violation. "Hot issue allocations routed to spouse's account before client allocations" = violation. "Family accounts placed last on IPOs to avoid the appearance of favoritism" = violation; treat them like any other client. "Routinely declined to file the personal transaction form" = both Michaels and his supervisor violate. "Traded for the firm's account ahead of report dissemination, claiming it was to facilitate later client sales" = violation. VI(C) Referral Fees Conceptual nuances Disclose to: employer, clients, prospective clients, as appropriate. Both incoming (you receive a fee for sending business) and outgoing (you pay a fee to someone who sends you business) referral fees must be disclosed. Disclosure timing: BEFORE entering into any formal agreement for services. Before the client agrees, they must know about the referral. Disclosure content: nature, value, type. Flat fee or %, one-time or continuing, performance-based, in-kind, soft dollars — all must be characterized in detail (including approximate dollar value). Referrals between departments of the same firm count. Internal payments to attract new business to a subsidiary require disclosure (Handley/Central Trust example below). Application patterns White/Lewis Brothers/Brady Securities/Maxwell: Brady refers tax-exempt accounts to Lewis Brothers. In return, Lewis Brothers (i) provides research to Brady, (ii) conducts monthly economic reviews for Brady, and (iii) routes all stock commission business to Brady. White, a Lewis partner, secures Maxwell as a new client (referred via Brady's Hill) but doesn't disclose the arrangement. Violation — Maxwell needed the disclosure to assess Hill's recommendation critically. Handley/Central Trust Bank: Handley works in the trust department; referrals to Central Trust's brokerage and personal financial management departments earn him compensation. He does not disclose the internal arrangement to clients. Violation — VI(C) does not distinguish internal from external referral payments. The disclosure must include the nature and value of the benefit. Roberts/Katama Investments/Naushon: Roberts directs a large portion of trading commissions to Naushon (a small broker run by her business school classmate) even though Naushon is not competitive on pricing and its research isn't useful. In return, Naushon recommends Roberts and Katama to its wealthy clients. Violation — failure to inform employer and clients about the referral arrangement. Arronski/state employee pension plan/Overseas Investments: the state plan hires Arronski as a consultant to find an emerging market manager. After Overseas wins, it's revealed that Arronski also charges fees to the managers he recommends if they win business. He didn't disclose this to the plan. Violation — withholding the manager-side compensation creates a potential lack of objectivity in the recommendation, regardless of whether Overseas was actually the best choice. Traps and tells "Internal referral arrangement between departments of the same firm" = disclosure required. "Independent consultant taking fees from both the plan and the recommended manager" = violation without disclosure to all parties. "Disclosure happened only after the client had already engaged" = late; the rule is before any formal agreement for services. "Soft dollar referral arrangement that wasn't quantified in the disclosure" = inadequate. "Referred clients to a sister entity in the bank without telling them" = violation. STANDARD VII: RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA CANDIDATE VII(A) Conduct as Participants in CFA Institute Programs Conceptual nuances Applies to all CFA Institute programs, not only the CFA designation. This includes CIPM, certificates, and other credentialing programs. Doesn't impose Code & Standards on non-members participating in CFA programs unless they're already members or candidates subject to the Code. Prohibited conduct (from the handbook's express list) Cheating (giving or receiving help on exams). Violating CFA Institute program rules / regulations / testing policies. Disclosing confidential program or exam information. Circumventing exam security measures. Improper use of association with CFA Institute for personal/professional gain. Misrepresenting information to CFA Institute about any program. Confidentiality of exam content Cannot disclose specific question details OR broad topical areas tested or not tested. Both kinds of information are confidential until CFA Institute publicly releases them. Discussion of nonconfidential information (e.g., how a topic is covered in published curriculum) is acceptable in study groups. All aspects of an exam are confidential until released. Volunteers (DRC, graders, committee members) Volunteers exposed to confidential material must not offer, solicit, or disclose: Questions appearing on or under consideration for an exam. Deliberation related to an exam process. Information related to scoring of questions. Right to express opinions Members and candidates can disagree publicly with CFA Institute policies, procedures, or advocacy positions. But cannot disclose confidential information (actual exam questions, subject matter coverage) when expressing opinions. Application patterns — what crosses the line Sharing actual exam questions in chatrooms (Nero): all three candidates (Nero who shared, plus the two who solicited and used) violate. Fraudulent deferral request (Chiu): filing a free Emergency Deferral by claiming an uncle's death (and then a mother's death with falsified document) when neither happened, to save money. Violations of both VII(A) and I(C) Misrepresentation. Disruptive conduct at the test center (Hermosa): refusing to show empty pockets, shouting profanities, throwing passport, threatening proctor. Violation. Bringing notes into the exam (Yu): writing formulas on a piece of paper hidden in a sleeve. Violation. Looking at neighbor's screen (Sharma): even brief curiosity-based looks. Violation. Posting exam content (Rossi): stating "tons of derivatives questions, I think 18!" and "no questions at all about IPO allocations" → both inclusions and exclusions of topics are confidential. The question count and statement that a topic was not covered are violations even though Rossi's general comments about exam difficulty are not. Discussing the most challenging questions in a forum (Gagne): even attempting to identify correct answers involves discussion of confidential question details. Violation. Test-prep company solicitation of post-exam content (Pena/CFA4Sure): Pena sharing the questions she found most difficult = violation (and CFA4Sure's employees, if members or candidates, also violate). Discussing grading guideline answers (Whitcomb): revealing which question he graded, the guideline answer, and that few candidates scored well = violation. Volunteers' confidentiality obligations are strict. Volunteer-position abuse Ramirez/local society program chair: scheduling only his own consulting clients to present to the society. Violation — using the volunteer position to benefit himself and his clients compromises CFA Institute's reputation. Warrenski/GIPS Standards Technical Committee: telling clients her committee membership will help them with GIPS compliance and implies she has access to advance information. Violation — implying special advantage from a confidential position. She may factually state her involvement but cannot infer special benefits to her clients. Traps and tells "Two days after the exam, posted some details about question coverage" = violation; broad coverage information is confidential. "There was an unusually large number of questions on derivatives" = confidential. "There were no questions on Topic X" = confidential (negatives are protected too). "Filed a free Emergency Deferral with a fake death certificate" = VII(A) and I(C). "Wrote formulas on paper to bring into the exam" = violation. "Looked at neighbor's screen out of curiosity" = violation. "Volunteer using committee membership to imply advance access for her clients" = violation; factual statement of involvement OK, implied advantage not OK. "Stated 'I passed Levels I, II, and III in three consecutive sittings'" = NOT a violation (statement of fact). "Stated 'I passed all three exams in three consecutive sittings, and so I am among the elite'" = violation (implies superior ability). VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program Conceptual nuances Factual statements about earning the CFA designation are permitted. Statements about thoroughness, rigor, ethical commitment, the requirements of the CFA Program — these are factual and OK. Implications of superior ability or performance based on holding the designation are not permitted. "CFA charterholders achieve better performance" is a violation. Personal opinions about CFA Institute, the exams, or the Code & Standards are permitted if expressed (implicitly or explicitly) as opinions. Applies to every form of communication — letterhead, business cards, biographies, directory listings, advertising, LinkedIn pages, email signatures, websites, resumes — and to oral statements. Membership requirements (annual, must be met to use the designation) 1. Complete a CFA Institute Membership Agreement. 2. Submit a completed Professional Conduct Statement (renewing the commitment to abide by Code & Standards and the PC Program). 3. Pay annual CFA Institute membership dues. If a member fails any of these: Individual is no longer a member. Cannot present as a member. Must remove all references to membership and (for charterholders) the CFA designation from social media, business communications, reports, etc. May state that they were members in the past, or refer to the years when they met the requirements. Charterholders The right to use "CFA" requires both (i) earning the right (through completion of the program) and (ii) maintaining annual membership. If a charterholder lapses on membership, the right to use the designation is forfeited until reinstated. A "retired" status with reduced dues is available, but it requires a separate application — it does not happen automatically (Simpson example). Pseudonyms tagged with the CFA designation are violations. "Expert, CFA" used to hide identity = violation (Glass example). Candidacy A person is a candidate if (i) CFA Institute has accepted the application (a notice of acceptance has been issued), AND (ii) the person is enrolled to sit for a specified examination, OR has sat for a specified exam but results haven't been received yet. If a candidate declines to sit, candidacy ends until the person re-enrolls for a future exam. Candidates can reference candidacy, but must clearly state they are a candidate. Candidates must not state or imply a partial designation. Candidates must not cite an expected completion date for the charter. "Charter Pending" is impermissible. The good vs. bad reference table — pattern reference Permitted Not permitted "Becoming a charterholder enhanced my portfolio management skills." "CFA charterholders achieve better performance." "John Smith passed all three CFA exams in three consecutive sittings." "John Smith is among the elite, having passed all three CFA exams in three consecutive attempts." "The CFA designation is globally recognized and attests to a charterholder's success in a rigorous and comprehensive study program." "As a CFA charterholder, I am the most qualified to manage client investments." Permitted Not permitted "The credibility the CFA designation affords and the skills the CFA Program cultivates are key assets for my future career." "As a CFA charterholder, Jane White provides the best value in trade execution." "I enrolled as a candidate for the CFA designation to obtain the highest set of credentials in global investment management." "Enrolling as a candidate for the CFA designation ensures becoming better at valuing debt securities." "I passed the Level II CFA exam." "CFA, Level II" "I am a 20XX Level III candidate for the CFA designation." "CFA, Expected 20XX" "I passed all three levels of the CFA exam and will be eligible for the CFA charter upon completion of the required work experience." "John Smith, Charter Pending" Application patterns Zonder/AZ Investment Advisers: advertisement that all firm principals are charterholders who passed on the first try, prominently linked to the firm's superior performance. The statement of consecutive passing per se is fine, but linking it to performance / implying superior ability is a violation. Vasseur: five years a charterholder, traveled abroad two years, didn't pay dues or file PCS. Without reinstating, prints business cards displaying "CFA." Violation. Simpson: retired, didn't pay dues / file PCS, plain business card with "CFA" after his name. Violation — there is a "retired" status with reduced dues, but he hasn't applied for it. He must complete the appropriate process. Reese: in conversation with a friend considering enrollment, says she learned a great deal as a CFA candidate, that many firms require employees to be charterholders, recommends the program. Compliance — these are facts and informed personal experience. Glass/"Expert, CFA": uses fictitious name on a blog comment to hide identity while still claiming to be a charterholder. Violation. Traps and tells "As a CFA charterholder, I provide..." superior X = violation. "I passed all three exams on my first try, so I am among the elite" = violation. "I passed all three exams in three consecutive sittings" = compliance (statement of fact). "CFA, Level II" on a business card = violation. "CFA, Expected 20XX" = violation. "Charter Pending" = violation. "Lapsed membership but kept 'CFA' on the business card" = violation, even if retired. "Pseudonym + CFA" = violation. "In my opinion, the CFA Program is more rigorous than [X]" = compliance (opinion). CROSS-CUTTING PATTERNS THAT REPEAT ACROSS STANDARDS These are the recurring fault-lines. When you see one of these patterns in a vignette, you can usually identify which standard is in play even before the question. "Disclosure is enough" vs. "Must avoid" The standards draw a hard line between conflicts that must be avoided and conflicts that can be managed by disclosure. Must avoid (disclosure does not cure): Compensation tied to the conclusions of analyst research / to the specific outcome of a recommendation (I(B), VI(A)). Compensation tied to attracting new investors to a covered security. Equity warrants / stock awards in covered companies that depend on positive coverage. Trading on material nonpublic information (II(A)). Manipulating prices/volumes (II(B)). Patently unfair allocation procedures, even with client consent (III(B)). Can be salvaged by disclosure: Most personal stock ownership in covered companies (VI(A)). Family member ownership. Performance bonuses from clients (I(B), III(A), IV(B), VI(A)) — disclose to employer. Soft commissions and directed brokerage (III(A)) — disclose may-not-get-best-execution. Investment banking relationships (VI(A)). Issuer-paid research with flat fees (I(B), VI(A)). Referral fee arrangements (VI(C)). Solicitation vs. preparation (around departure / outside business) Drawn sharply across IV(A): Allowed: registering a competing entity, drafting business plans on personal time, building general arrangements that don't operate yet, contacting former clients via public information after departure, updating LinkedIn after departure. Not allowed: soliciting current clients, taking firm property (including spreadsheets you built), describing new firm services to current clients, disparaging the current employer to clients, RFP-bidding while the current firm bids, providing new firm contact info before leaving, posting recommendations that disclose the firm's positions. Family accounts treated as ordinary clients Across III(A), III(B), VI(B): If the family member is a fee-paying client managed similarly to others, treat the account exactly like any other client — no special favors (III(A) Toffler), no exclusion from IPO allocations (III(A) Dill). If the family member's account is not a client (managed outside the normal fee structure or held outside the firm), VI(B) priority of transactions kicks in: client > employer > family/personal. Mosaic and the analyst's defensive positioning II(A) gives analysts a wide creative space — public + nonmaterial nonpublic information can produce conclusions the company itself hasn't disclosed. The defensive practice (mentioned in II(A) but also relevant to V(A), V(C)) is: Document the inputs. Maintain support records. Be able to show that the conclusion came from analysis, not a tip. Performance and composite manipulation Across I(C) and III(D): Cherry-picking accounts for composites = violation. Excluding terminated accounts = violation. Switching attribution methodology to flatter results = violation. Switching pricing providers to obtain higher valuations = violation. Using simulated returns without disclosing simulation = violation. Carrying performance from a prior firm without disclosing the source and the member's role = violation. Manipulating composite construction over time = violation. Single-year results presented as expected returns = violation. "Reasonable" / "Should have known" / "Knowingly" Across the standards, "knowingly" is consistently expanded to include "should have known." Senior officials are presumed to have known about repeated misrepresentations in firm marketing material (Muhammad / I(C)). Supervisors are presumed to have known about misconduct in their patch when they took no steps to prevent or detect (Bartolucci / IV(C)). This is the most common prosecution theory in the application examples. Time pressure / urgency is never a defense Hawke's IPO time pressure (V(A)). Halsey's market trend pressure on cryptocurrency (I(E)). Liakos's quick-turnaround derivative strategy (V(A)). Stefansson's manager search recommendation (V(A)). Snead's quarterly performance bonus pressure (III(C), VI(A)). Glusker's licensing exam pass without learning (I(E)). Document, document, document Many examples turn on the absence of documentation. Maintaining records protects the member when: A research conclusion is challenged (V(C)). A dissociation or whistle-blow needs evidence (I(A), IV(A)). An IPS adherence is challenged (III(C), V(C)). A vulnerable-investor disclosure is questioned (III(E)). A composite calculation is reviewed (III(D)). A mosaic-theory conclusion is investigated (II(A)). PARTING ADVICE FOR EXAM-DAY PATTERN RECOGNITION When reading a vignette, ask in this order: 1. Whose interest is being served at whose expense? Conflicts almost always show up as someone (member, firm, employer) benefiting at someone else's expense (client, beneficiaries, market participants). 2. Was avoidance reasonably possible? If yes, disclosure is not enough. 3. What is the temporal sequence? Pre-trade vs. post-trade. Pre-publication vs. postpublication. Pre-resignation vs. post-resignation. Pre-IPS-update vs. post-IPS-update. Predisclosure vs. post-disclosure. Most violations are about doing the right thing in the wrong order. 4. Who is the client? Pension plan beneficiaries vs. plan sponsor. Fund's mandate vs. fund's investors. Law firm vs. independent witness. The wrong identification of the client is half the violations in III(A). 5. Was the action knowingly done, or should it have been known? Senior personnel and supervisors carry "should have known" presumptions. 6. Is this a "must avoid" category, or can disclosure save it? The line is sharp on compensation tied to outcomes vs. compensation tied to performance. 7. Is the underlying behavior genuinely professional in nature? I(D) is narrow — the activity must touch employment, the investment profession, or the use of the charter / membership. 8. Are documents in place to support the position? The applicant's lack of documentation is often the determinative factor. The handbook's examples are repetitive across standards because the same fault-lines repeat. Once you internalize the patterns above, most Level II ethics questions resolve mechanically. End of guide.