Ethical and Professional Standards - Session 1 - Reading 3 - LOS b

CFA Level 2 - Ethical and Professional Standards Session 1 - Reading 3 - LOS b (Notes, Practice Questions, Sample Questions) 1. Sharon Fischer manages an equity mutual fund, and she uses soft dollars generated on this account to obtain municipal bond research for an associate whose fund is small and does not generate a sufficient level of soft dollars for his municipal bond research needs. With regard to this action, which of the following statements is most accurate? This action is: A) not permissible; Fischer is not in violation of her fiduciary duties. B) not permissible; Fischer is in violation of her fiduciary duties. C) permissible; Fischer is not in violation of her fiduciary duties Explanation: (B) — Since the research purchased is not relevant to the client assets generating the soft dollars, the action is not permissible. By this action, she is effectively transferring assets belonging to the equity clients to the clients of the municipal fund. This is in violation of the Code and Standards 2. Waldmann Brothers & Company offers Pyramid Investment Advisors the use of its proprietary investment allocation software. This package is purported to improve the risk-return trade-off for assets under management, and is also useful for the generation of various diagnostic reports that will benefit Pyramid. Goldman, Pyramid’s CEO estimates that about 70 percent of the value of the package is the improvement of the risk-return trade-off, and that this will be valuable to the holders of Pyramid’s Growth Fund. The remaining value of the package accrues to Pyramid in the form of increased management efficiency. If the value of the package is $50,000 per year, how much of this must be paid by Pyramid? A) $15,000. B) $35,000. C) $50,000. Explanation: (A) — Since approximately 30 percent of the value of the asset accrues to the management of the investment firm, 0.30 * 50,000 = $15,000 should be paid by Pyramid. The remainder can be funded with soft dollars, since the balance of the value will accrue to the clients who will directly benefit from the acquisition of the asset 3. Marc Schultz manages an equity mutual fund, and he uses soft dollars generated on this account to obtain equity research to assist him in managing the portfolio. With regard to this action, which of the following statements is CORRECT? This action is: A) permissible; Schultz is not in violation of his fiduciary duties. B) not permissible; Schultz is in violation of his fiduciary duties. C) not permissible; Schultz is not in violation of his fiduciary duties Explanation: (A) — Since the research is relevant to the client assets and is used for the benefit of the client, the action is permissible, and there is no violation 4. Springfield Investment Advisors uses soft dollars generated with mutual fund transactions to get software that is used 50% of the time to assist in the management of client assets. Which of the following statements is CORRECT? This action is: A) permissible only if the firm pays for 50% of the software cost with its own resources. B) not permissible since items purchased must provide 100% of their benefits to clients. C) permissible since items purchased with soft dollars must be tangible, and software is intangible Explanation: (A) — As long as the software is used for the benefit of clients 50% of the time it is permissible to pay for 50% of the software with soft dollars. The remainder must be paid for by the firm with its own resources 5. Springfield Investment Advisors uses soft dollars generated with mutual fund transactions to get software that is only useful for the management of the investment firm. Which of the following statements is CORRECT? This is: A) not permissible since items purchased with soft dollars must provide at least 50% of their benefits to the client. B) not permissible since items purchased with soft dollars must provide a benefit to the client. C) permissible since items purchased with soft dollars must provide a benefit to the firm Explanation: (B) — This action is not permissible—items purchased must provide a benefit to the client. The firm is responsible for securing assets necessary for the operation of the firm from the firm’s resources 6. Jason Wariner manages an equity mutual fund and directs trades to various brokers on the basis of their research coverage of the equity being traded. The commissions paid vary somewhat (i.e., he knows that he could occasionally save on the commission by dealing with a broker other than the one handling the transaction) but are believed to be reasonable in relation to the research and execution services provided. With regard to this practice, which of the following statements is CORRECT? This action is: A) not permissible; Wariner is in violation of his fiduciary duties. B) permissible; Wariner is not in violation of his fiduciary duties. C) not permissible; Wariner is not in violation of his fiduciary duties Explanation: (B) — Since the research is relevant to the client assets and is used for the benefit of the client, the action is permissible, and there is no violation so long as the value of the research obtained is commensurate with the differential in cost paid 7. Rochelle Bell is the Chief Investment Officer at a money management company that claims it is in compliance with CFA Institute Soft Dollar Standards. Last year the company had $10 million of soft dollar funds accruing from commissions available but only spent $8 million on research services. This year Bell estimates that the company will have $11 million of soft dollar funds available. Bell analyzes the research services that the firm wishes to purchase and places them into four categories: fully available for soft dollars, mixed usage, not available for soft dollars, and cannot be determined. The total of soft dollars allocated to the first two groups is $7 million, and there are $500,000 of expenditures in the group for which she cannot determine whether they are suitable for soft dollar expenditures. Bell should: A) allocate $500,000 of this year's soft dollars to this last group. B) use the 50-50 rule and allocate $250,000 of soft dollars to this last group. C) not allocate any of the soft dollars to this last group. Explanation: (C) — In cases when the manager cannot determine whether the expenditure qualifies for soft dollars, soft dollars cannot be used 8. Springfield Investment Advisors uses soft dollars generated with mutual fund transactions to get software that is only useful for the management of client assets. Which of the following statements is CORRECT? This is: A) not permissible, since items purchased with soft dollars must provide a benefit to the firm. B) permissible, since items purchased with soft dollars must provide a benefit to the client. C) not permissible, since items purchased with soft dollars must be tangible, and software is intangible. Explanation: (B) — This action is permissible, since the software is relevant and provides a benefit to the client 9. Elaine Black, CFA has recently been hired as the Chief Investment Officer at a money management company that does not claim it is in compliance with CFA Institute Soft Dollar Standards. Her former company was in compliance. Which of the following statements concerning CFA Institute Soft Dollar Standards is CORRECT? Black: A) cannot use soft dollars to pay for research services except when the commissions originate from principle trades. B) must ignore all provisions set forth in the CFA Institute Soft Dollar Standards except when they are consistent with the Standards of Professional Conduct. C) must abide by the conditions set forth in the Standards of Professional Conduct concerning soft dollars and can chose to accept some of the CFA Institute Soft Dollar Standards Explanation: (C) — Black must abide by the Standards of Professional Conduct, but can still follow any of the Soft Dollar Standards that she desires 10. Liz Davis is a portfolio manager for a firm that claims it is in compliance with CFA Institute Soft Dollar Standards. In purchasing bonds for the account of the pension fund of Richards Company, no commissions were paid but there was a spread charged by the broker between the purchase and sale price of the bonds. The brokerage on the trade is not governed by any securities regulation. The specific brokerage from the trade: A) cannot be used to benefit any other client. B) can be used to benefit another client as long as Davis receives prior consent from Richards. C) can be used to benefit another client as long as Richards benefits from other the client’s brokerage in the future Explanation: (B) — Prior consent must be given in the case of a principal trade