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#analyst-notes #code-of-ethics-and-standards-of-professional-conduct
Members and Candidates must:
  • Use reasonable care and exercise independent professional judgment when conducting investment analysis, recommendations or actions, and engaging in other professional activities.

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Subject 2. The Six Components of the Code of Ethics
gues in the investment profession, and other participants in the global capital markets. Place the integrity of the investment profession and the interests of clients above their own personal interests. <span>Use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities. Practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession. Promote the integrity of, and u




C. Suitability.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
Example 1

After a five-minute interview, you advise a client how to invest a substantial proportion of her wealth. You have violated the "Know your customer" rule. You do not have adequate basis to make a detailed recommendation.

Example 2

An analyst tells a client about the upside potential, without discussing the downside risks. He violates the standard because he should discuss the downside risks as well.

Example 3

When recommending an investment to a client, an analyst mainly focuses on the characteristics of the specific investment. He violates the standard because the primary focus for determining the suitability of an investment should be on the characteristics of the entire portfolio.

Example 4

Should a firm move from a fundamental approach to selecting stocks to a more technically-based model, it would need to communicate this change to all of its current and prospective clients. Clients must always be made aware of the risk of investing as well as possible downside risks. The portfolio must always be looked at as a whole.

Example 5

The portfolio managers at DD Investing sit down with Danielle to analyze her needs and circumstances. While discussing her position with her, they find out that a wealthy cousin left her $500,000 as part of her inheritance. This triples the size of her current portfolio. As a result of the increased funds, Danielle's willingness to assume risk has increased; she can now bear more risk. Therefore, the portfolio managers should now invest more funds in the equity side of her portfolio, to increase risk and potential returns.

Example 6

A client requests to change his investment strategy from investing in North-American blue chips to emphasizing countries with high economic growth rates. The portfolio manager should explain the potential risks and returns to the client, and ask him to consider them before changing the investment strategy.

Example 7

An investment manager uses the proceeds of some high yielding securities to invest 20% of the client's portfolio in a high-risk stock, because he believes that a merger is in place and will push the price of the stock up. He will then sell the stock and repurchase other high-yielding securities. The client depends on the portfolio for her support. The manager has violated this standard, since he has not considered the effects of each transaction within the context of the entire portfolio.

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D. Performance Presentation.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
When communicating investment performance info, you must make reasonable efforts to make sure that this information is FAIR, ACCURATE, and COMPLETE.

There have been several practices that obstruct performance presentation and comparability, such as:

  • Representative accounts - only the best results are presented.
  • Survivorship bias - accounts that have been terminated are excluded from the results presented.
  • Portability of investment results - results from previous employment are disclosed.
  • Varying time periods - only the results for the good time periods are reflected.

A firm cannot claim that they are/were in compliance with CFA Institute's standards unless they comply in allmaterial respects with CFA Institute's standards.

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D. Performance Presentation.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients

Procedures for compliance

Misrepresentations about investment performance of the firm can be avoided if the member maintains data about the firm's investments performance in written form and understands the classes of investments or accounts to which those data apply and the risks and limitations inherent in using such data. In analyzing information about the firm's investment performance, the member should ask the following questions:

  • How many years of past performance does this information reflect?
  • Does it reflect performance for the prior year only, after several years of poor performance, or an average of several years of performance?
  • Has the performance been measured in accordance with CFA Institute's standards?
  • Does investment performance vary widely among different classes of funds or accounts? If so, the member must describe investment performance by classes rather than by an overall average figure and accurately explain what the performance figures represent.

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D. Performance Presentation.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
Example

Your bond fund has generated a below average performance for four of the past five years. You use this as the basis for expectations of an above-average performance for the upcoming year. If your average or expected performance is properly determined, you should have a 50% probability of meeting or exceeding that average. Thus, it is inappropriate to declare that because performance was below average last year it is likely to be above average next year.

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E. Preservation of Confidentiality.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
E. Preservation of Confidentiality.

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

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

You must preserve confidentiality when the following two criteria are met:

  • You must be in a relationship of TRUST with the client who has engaged you.
  • The information received must result from or be relevant to the part of the client's business that is the subject of the confidential relationship.

You are required to:

  • Avoid discussing any information received from a client, except to fellow employees working with the same client.
  • Ask yourself if the disclosure is necessary and beneficial to the client in cases where you have to disclose information.
  • Forward confidential information to the PCP (CFA Institute's Professional Conduct Program) if the PCP requests, even if the client and you have a settlement agreement with confidentiality clauses. This is because any information turned over to the PCP is kept in the strictest confidence. Members and candidates who will not provide necessary information because of confidentiality will be seen as failing to co-operate with the investigation and will be subject to summary suspension of membership under CFA Institute's bylaws.

However, if the information concerns illegal activities by the client, the analyst may be required to consult with his supervisor and with legal counsel before deciding whether to report the activities to the appropriate governmental organization.

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E. Preservation of Confidentiality.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
Procedures for compliance

The simplest, most conservative, and most effective way to comply with this standard is to avoid disclosing any information received from a client except to authorized fellow employees who are also working for the client. In some instances, however, you may want to disclose information received from clients that is outside the scope of the confidential relationship and does not involve illegal activities. Before making such a disclosure, a member should ask the following questions:

  • In what context was the information disclosed?
  • If disclosed in a discussion of work being performed for the client, is the information relevant to the work?
  • Is the information background material that, if disclosed, will enable the member to improve service to the client?

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E. Preservation of Confidentiality.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iii-duties-to-clients
Example 1

You work in the trust department of a large bank. A client tells you that she must sell a significant portion of her personal stock portfolio in order to generate cash to meet the payroll of her small business. Shortly after the meeting, a colleague in the commercial lending department of the bank mentions seeing you with the client. She has applied for a large business loan. He asks you if you have any information that could help the bank with the loan decision. You cannot disclose the content of your meeting with the client. If the colleague wants additional information, he should contact your client directly.

Example 2

The employer of a client asks to meet with you. The employer suspects your client of embezzling funds from his place of work. You are aware that the client has made several substantial additions into his discretionary account during the past two months. It may be appropriate to provide information if it pertains to illegal activities. However, you are expected to preserve client confidentiality unless there is a clear indication of these activities. Contact your supervisor or legal counsel before providing information about your client.

Example 3

A financial advisor learns that a client plans to make a charity donation. He tells a charity to solicit donation from the client. The financial advisor violates the standard for revealing confidential client information.

Example 4

An analyst claims that he cannot disclose client trading information to CFA Institute's PCP committee. He therefore violates the standard for not providing confidential client information to the PCP.

Example 5

A member receives a request from a government department to review a client's records on account of some suspicion. The member may have to disclose the information to the government department.

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A. Loyalty.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers

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

Independent practice

You shall not undertake any independent practice that could result in compensation or other benefit in competition with their employer unless they obtain written consent from their employer.

  • "Practice" means any service that the employer currently makes available for payment.
  • "Undertake" means that you actually have to PARTICIPATE in such activities while you are still employed in order to violate this standard.

If you plan to engage in independent business while still employed, they must provide a written statement to their employer describing the types of services, the expected duration, and the compensation.

Note: Members have to participate in the activities. They do not actually have to receive any remuneration for this standard to apply.

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E. Preservation of Confidentiality.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Leaving an employer

Until their resignation becomes effective, you must continue to act in the employer's best interest, and must not engage in any activities that would conflict with this duty. A member can make preparations (but not undertake competitive business) to begin a competitive business as a departing employee, provided that the preparations do not breach the employee's duty of loyalty. Examples of this would be finding office space to rent for a member's future business.

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A. Loyalty.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Nature of employment

You can be exempt from the standard if you are an independent contractor.

Definition of employee: someone in the service of another who has the power to control and direct the employee in the details of how work is to be done. An employee is not a contractor (you cannot control the details of how a contractor does a job). Employment relationship does not require written or implied contract or actual receipt of monetary compensation.

Violations

  • You get a new job, but before leaving your current job you solicit your employer's clients (for both current and potential clients).
  • Misuse of confidential information or misappropriation of trade secrets (e.g., taking home client lists, investment statements, marketing presentations, and buy lists).
  • You provide consulting services on your own time. You must get written consent from your employer.
  • Copying your employer's computer models and other property.
  • Encouraging colleagues to leave your employer to join your new company.

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A. Loyalty.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Example 1

You agree to serve as an investment advisor to a non-profit institution run by a friend. Your firm provides similar services, but you elect to do this on your own for a very modest fee. Even if no fee was involved, you are obliged to obtain written consent from your employer.

Example 2

An independent investment advisor is hired by a brokerage firm. However, she wants to keep her existing clients for herself. In this case, she must get the employer's written consent.

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B. Additional Compensation Arrangements.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
You must not accept gifts, benefits, compensation, or consideration that competes with, or might reasonably be expected to create a conflict of interest with, your employer's interests unless you obtain written consent from all parties involved.

Outside compensation/benefits may affect loyalties and objectivity and create potential conflicts of interest. These include direct compensations from CLIENTS and indirect compensations or other benefits from third parties.

Note: Accepting gifts is allowed, but you must inform your employer in writing before accepting.

Procedures for compliance

You should make an immediate written report to you employer specifying any compensation you receive or propose to receive for services in addition to compensation or benefits received from your primary employer. Disclosure in writing means any form of communication that can be documented (e.g., email). This written report should state the terms of any oral or written agreement under which a member will receive additional compensation. Terms include the following:

  • Nature of the compensation.
  • Amount of compensation.
  • Duration of the agreement.

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B. Additional Compensation Arrangements.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Example 1

In an attempt to increase portfolio performance, a firm's client offers the portfolio manager an incentive, such as a free vacation. A conflict of interest exists in this case and the portfolio manager must inform the firm before accepting the arrangement.

Example 2

One of your firm's clients manages a ski resort in Colorado. She has told you that as long as you are managing her assets, you are entitled to complimentary lift tickets at the resort. To be in compliance with this standard, you must report this in writing to your employer. The employer will want to ensure that this client receives no special consideration as a result of the arrangement.

Example 3

Steve sits on the board of directors of ABC Inc. As a result, he obtains unlimited membership in ABC Inc.'s services. Steve does not disclose this relationship to his employer, because he does not receive monetary compensation. Steve has violated this standard by not disclosing the benefits he receives to his employer.

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C. Responsibilities of Supervisors.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
You must make reasonable efforts to detect and prevent violations of applicable laws, rules, regulations, and the Code and Standards by anyone subject to your supervision or authority.

If you supervise large numbers of employees, you may not be able to evaluate each. In this case, you may delegate supervisory duties; however, such delegation does not replace supervisory responsibilities.

A supervisory member should rely on reasonable procedures to detect and prevent violations. The presence of a compliance policy manual and/or compliance department, however, does not remove his or her supervisory responsibilities.

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C. Responsibilities of Supervisors.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Procedures for compliance

A supervisor complies with Standard IV (C) by identifying situations in which legal violations or violation of the Code and Standards are likely to occur, and establishing and enforcing compliance procedures to prevent such violations.

If a firm does not have a compliance system, or the system is not adequate, you should DECLINE in writing to accept supervisory responsibility until the firm adopts reasonable procedures.

Adequate compliance procedures should:

  • Be drafted so that the procedures are easy to understand.
  • Designate a compliance officer and clearly define the officer's authority and responsibility.
  • Outline the scope of the procedures.
  • Outline permissible conduct.
  • Delineate procedures for reporting violations and sanctions.

Once a compliance program is in place, a supervisor should:

  • Disseminate the contents of the program to appropriate personnel.
  • Periodically update procedures to ensure that the measures are adequate under the law.
  • Continually educate personnel regarding the compliance procedures.
  • Issue periodic reminders of the procedures to appropriate personnel.
  • Incorporate a professional conduct evaluation as part of the employee's performance reviews.
  • Review the actions of employees to ensure compliance and identify violators.
  • Take the necessary steps to enforce procedures once a violation has occurred.

Once a violation is discovered, a supervisor should take the following actions:

  • Respond promptly.
  • Conduct a thorough investigation of the activities to determine the scope of the wrong-doing.
  • Increase supervision or place appropriate limitations on the wrongdoer pending the outcome of the investigation.

If a supervisory member was unable to detect violations, he or she may not violate the standard if he or she takes steps to institute an effective compliance program AND adopts reasonable procedures to prevent and identify violations.

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C. Responsibilities of Supervisors.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #iv.-duties-to-employers
Example 1

A supervisor in an investment management firm concludes that since all five equity analysts working for her are CFA charterholders, she can trust them to refrain from violations of laws, regulations, and the Code and Standards. While she can trust them to refrain from such violations, this does not constitute reasonable supervision.

Example 2

You are offered a promotion to supervise all investment managers involved in discretionary trading. You are told that there have been instances of improper trading in some accounts and that at least one manager is likely performing additional investment services for several of his clients. However, the operation is highly profitable, so senior management has no immediate concern regarding these issues. You are responsible for prevention of violations of the Code and Standards. If there are known violations and little or no control over the investment process, you should decline the supervisory position until reasonable procedures can be established.

Example 3

A supervisor returns from a two-week vacation to find that one of his brokers has been making personal trades in advance of the release of analysts' reports to clients. If there are established reporting processes to monitor employee trading and a reasonable effort is made to evaluate the appropriateness of trades, then the supervisor has not violated this standard. However, if there is no reasonable monitoring process, the supervisor has violated this standard.

Example 4

A supervisor obtains a memo from an employee stating that all the portfolio managers should purchase a certain stock. He doesn't check the sources of the memo or anything else, disseminates the memo to all his portfolio managers and then leaves town. The price of the stock declines sharply. The supervisor is in contravention of this standard, since he was negligent and didn't check the memo prior to disseminating it.

Example 5

A supervisor/vice president of a large investment company changes her opinion on a specific stock from buy to sell. Prior to publishing the change of opinion, she informs all her colleagues (as is normal practice). Several of the employees sell the stock prior to the dissemination of the report to the public. The supervisor was negligent in the performance of her duties, as she should have ensured that there were procedures in place to ensure that no trading took place until the information was disseminated to the general public.

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A. Diligence and Reasonable Basis.
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #recommendations #v.-investment-analysis

You must:

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

You must perform the investigations necessary to make an investment recommendation or action. Three factors determine the nature of the diligence, thoroughness of the research, and level of investigation required by the standard:

  • Investment philosophy followed.
  • The role of the member or candidate in the investment decision-making process.
  • The support and resources provided by the employer.

Members must establish a reasonable basis for all investment recommendations and actions. Diligence must be exercised to avoid any material misrepresentation. In other words, members cannot be quick or negligent in making investment recommendations.

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A. Diligence and Reasonable Basis.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #v.-investment-analysis-recommendations-and-actions
Using secondary or third-party research

Secondary research: research conducted by someone else in the firm.
Third-party research: research conducted by entities outside the member or candidate's firm.

You should check if research is sound. Examples of criteria include the assumptions used, the rigor of analysis, the timeliness of the research, and the objectivity and independence of recommendations. If the research is suspected to lack a sound basis, members and candidates should refrain from relying on it.

Applications:

  • A quantitative analyst recommends an out-of-favor stock based on analysis of its 3-year records: the recommendation is not based on thorough quantitative work. A longer time period should be covered.

  • Because of restrictions from the firm's executives, an analyst cannot obtain the information necessary to perform analysis: the analyst must let the client know when he/she is "conflicted" or "restricted."

  • Because lack of research resources, an analyst decides to estimate IPO prices based on the relative size of each company and justify the pricing later when she has time: her analysis is not based on thorough research with reasonable basis. She should take on the work only when she can adequately handle it.

  • An investment banker presses a securities issuer to project the maximum production level. He then uses these numbers as the base-case production levels during sales pitches: he misrepresents the chances of achieving that production level. He should have given a range of production scenarios during the pitch.

  • An analyst recommends purchasing what the market, in general, has christened "hot" stocks without further research: conventional wisdom of the markets does not form a reasonable and adequate basis.

  • After a discussion with the vice president, a senior analyst discovers that there is a good chance that this company will be awarded a large contract (thus pushing up the stock price). The analyst then publishes a report to his clients indicating that they must all purchase the stock based on the fact that the company will be awarded the large contract. The manager has violated this standard since he published that the company will definitely be awarded the contract, which is not necessarily the case.

  • An investment analyst publishes a report based on a 5-year history of the PE ratios of a company. This report will materially affect the portfolios of the firm's clients, since the analyst plans to use the results of the report to invest for his clients' portfolios. The analyst is in contravention of this section since he should have done further research prior to publishing and planning to implement such a huge proposal.

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B. Communication with Clients and Prospective Clients.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #v.-investment-analysis-recommendations-and-actions

You must:
  • Disclose to clients the basic format and general principles of the investment processes used to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes.
  • Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients.
  • Distinguish between fact and opinion in the presentation of investment analysis and recommendations.

All important factors relating to the investment recommendation must be included in the report. You must include known limitations in the analysis and conclusions in the report and consider all risks associated with the investment.

Members should consider including the following information in research reports:

  • Expected annual rate of return, taking into account cash flows and expected price changes during the holding period.
  • Annual amount of income expected (current and future).
  • Current rate of income return or yield to maturity.
  • Degree of uncertainty associated with cash flows.
  • Degree of marketability / liquidity.
  • Business, financial, political, sovereign, and market risks.

A report can be given in many forms: a written report, in-person communication, telephone conversation, media broadcast, or transmission by computer (e.g., on the Internet or by email).

Opinions should be distinguished clearly from facts. Specifically:

  • Past should be separated from future. Past represents facts, while forecast on future represents opinions.
  • In the case of quantitative analysis, facts should be separated from statistical conjecture.

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B. Communication with Clients and Prospective Clients.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #v.-investment-analysis-recommendations-and-actions
Procedures for compliance
  • The selection of relevant factors is an analytical skill, and determination of whether a member is in compliance depends heavily on case-by-case review. To assist the after-the-fact review of a report, the member must maintain records indicating the nature of the research and should, if asked, be able to supply additional information to the client (or any user of the report) about factors not included.
  • Members must take reasonable steps to assure themselves of the reliability, accuracy, and appropriateness of the data included in each report. If the data has been processed in any way (e.g., into financial ratios), a member should ascertain that such processing has been done in a manner consistent with the member's analytical purposes.
  • Acknowledgment of the source(s) should be made when appropriate.

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B. Communication with Clients and Prospective Clients.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #v.-investment-analysis-recommendations-and-actions
Example 1

To simplify his report, an analyst leaves out details of the valuation models. He violates this standard because clients need to fully understand the analyst's process and logic in order to implement the recommendation.

Example 2

An analyst issues a "buy" recommendation on a stock, mainly based on his optimistic assessment of the company's operation. He violates this standard by failing to distinguish between opinions and facts; his optimistic assessment of the company is his own opinion.

Example 3

An analyst issues a report promoting a firm's new investment strategy. The report stresses the likelihood of high returns. However, it does not describe the strategy in detail. The analyst violates this standard because his report fails to describe properly the basic characteristics of the investment strategy.

Example 4

An analyst has a duty to gather information about a company in order to make fully informed recommendations about it. As a result, the analyst is required to ask the management of the company to review his research report for inaccuracies. The analyst still has a duty to examine and verify the information presented to him by the company he is examining.

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C. Record Retention.
#analyst-notes #code-of-ethics-and-standards-of-professional-conduct #v.-investment-analysis-recommendations-and-actions

You must develop and maintain appropriate records to support investment analysis, recommendations, actions, and other investment-related communications with clients and prospective clients.

You should maintain files to support investment recommendations. In addition to furnishing excellent reference materials for future work, research files play a key role in justifying investment decisions under later scrutiny. Files can serve as the ultimate proof that recommendations and actions, good or bad, were made based on the same methodology that drove the analyst's decisions.

  • Records can be maintained either in hardcopy or electronic form (soft copy).
  • CFA Institute recommends maintaining records for at least seven years.
  • Records are the property of the member's or candidate's firm.

Example

If an analyst writes investment recommendations based on many sources, such as stock exchange data, interviews with senior management, onsite company visits, and other third party research, he or she should document and keep copies of all the information that goes into recommendations.

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A. Disclosure of Conflicts.
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest

You must make full and fair disclosure of all maters that could reasonably impair your independence and objectivity or interfere with respective duties to your clients, prospective clients, and employers. You must ensure that such disclosures are prominent, delivered in plain language, and communicate the relevant information effectively.

Conflicts can occur between the interest of clients, the interests of employers, and your own personal interest. In the investment industry, a conflict or the perception of a conflict often cannot be avoided and full disclosure is required.


1. Disclosure to Clients

You shall disclose to clients and prospects all matters, including beneficial ownership of securities or other investments, that reasonably could be expected to impair the members' ability to make unbiased and objective recommendations.

You must disclose to clients/prospects the following conflicts:

  • Material ownership in the member's firm's investment account.
  • Market-making activities.
  • Corporate finance relationships.
  • Directorships.



    The most obvious conflict that arises is when members own stocks in a company that they recommend to their clients.

  • Sell-side members must disclose any material beneficial ownership in a security. A sell-side analyst working for a broker or dealer may be enticed, for example, by corporate issuers to write research reports about certain companies.
  • Buy-side members should disclose their procedures for reporting requirements for personal transactions. A buy-side analyst will be faced with similar conflicts as banks exercise their underwriting and security-dealing powers. The marketing division may ask an analyst to recommend the stock of a certain company in order to obtain business from that company.
  • Service as a director of another firm poses three possible conflicts:

  • A possible conflict between the director's fiduciary duty to his or her clients and the director's duty to the shareholders of the firm.
  • A director may receive options to purchase securities or actual securities in his or her firm as part of a remuneration package. This may entice the director to push up the price of the firm's securities.
  • A director is likely to become aware of material nonpublic information, which may place him or her in a position of possible conflict.
  • Members should also disclose, with approval from their employers, special compensation arrangements with the employer that might conflict with clients' interests, such as bonuses based on short-term performance, commissions, performance fees, incentive fees, and referral fees.

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A. Disclosure of Conflicts.
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest

Procedures for compliance

Many firms require employees and their families to report all transactions by employees and their families for purposes of detecting conflicts of interest and trading on material nonpublic information. If this exists or not, you should report to employers, clients, and prospective clients any material beneficial interest you may have in securities and any corporate directorships or other special relationships they may have with the companies you are recommending. Members should make the disclosures before they make any recommendations or take any action regarding such investments.

There are two approaches to avoid potential conflicts of interest:

  • Avoidance: Personal investment through "blind trust" or "mutual fund," in which you have no influence on investment decisions.
  • Disclosures: As soon as the member has made full disclosure of the potential conflict, the client has all the relevant information to allow him or her to make a decision regarding the investment.

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Disclosure of conflicts to clients
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
Example 1

Failure to disclose a performance-based bonus plan: A manager gets a bonus from her employer based on the performance of the pension accounts she manages. One of her clients asks her why his pension plan seems to be weighted in favor of high beta stocks. She says nothing about the bonus plan.

Example 2

You manage the pension fund for the Tremont Corporation. Huntington Biomedical is one of the largest holdings in the fund. You also serve on the board of directors for Huntington. You must disclose this relationship. While it is not unethical to have a responsibility to the fund's beneficiaries and to the shareholders of Huntington, you must make sure that the fund's board is aware of your other appointment.

Consider the same scenario, but instead of being on Huntington's board, you own a significant block of Huntington stock. You must disclose this beneficial ownership too. As long as you do not violate other standards regarding Priority of Transactions or Fair Dealing, disclosure of your holdings will be sufficient to meet this standard.

Example 3

An analyst recommends a stock. However, he fails to disclose that he is on the company's board or that he has inherited a sizable amount of the stock, or that his wife owns 20% of the company. The standard is violated by the analyst's failure to disclose his beneficiary interest in the recommended company.

Example 4

Company XYZ is considering hiring John to manage its pension fund. XYZ asks John to vote the XYZ stock proxies held in other accounts he manages in favor of XYZ's management. John will violate the standard if he accepts XYZ's offer. He should vote the proxies in the best interest of his clients.

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2. Disclosure of Conflicts to Employers
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest

You should:

  • Disclose to employer all matters, such as beneficial interest (ownership of securities), corporate directorships, trusteeships and any special relationships, that reasonably could be expected to interfere with their duties to employers or abilities to make unbiased and objective recommendations.
  • Comply with any prohibitions on activities imposed by their employers if a conflict of interest exists.
  • Discuss any action involving conflict of interest with their firm's compliance officer.

Many firms restrict employees' investment activities to avoid conflicts of interest. Members should obey their employers' guidelines. However, you are not required to desist from personal trading and board memberships, if your employer allows them.

Procedures for compliance

  • Report to employers any beneficial interest and special relationships (e.g., corporate directorships) that may be considered a conflict of interest.
  • Discuss with compliance officers or supervisors before taking any actions that could lead to such conflict.

Example 1

You come from a wealthy family that made much of its fortune in the automotive industry. You and your family still have a considerable position in several stocks in the industry. You are employed as an industry analyst in the automotive sector. You are obliged to disclose your beneficial ownership to your employer.

Example 2

Mark makes personal trades without compliance with his firm's prohibition as the firm has no intention of trading these stocks and Mark does not cover that particular industry within the firm. Mark violates the standards for ignoring the firm's trading prohibitions. He should realize that the firm's policy is designed to prevent material conflict of interest and the appearance of conflict.

Example 3

John acts as a trustee for another company. However, he has NOT disclosed his involvement to his employer. He violates the standard, as it prohibits a member's conflict of interest that might be detrimental to the employer's business. Being a trustee can be time-consuming, and thus detrimental to the firm.

Example 4

An investment manager with a large firm believes that his firm would not be interested in equity-linked notes, and as such purchases one for himself. One month later he prepares a report for his firm suggesting that they should start investing in equity-linked notes. The manager has violated this standard; his ability to make an unbiased decision is impaired since he already owns the notes himself.

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B. Priority of transactions
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
Investment transactions for clients and employers must have priority over investment transactions in which you are the beneficial owner.

This standard is designed to prevent any potential conflict of interest or even the appearance of a conflict of interest with respect to the analyst's personal transactions. Transactions for clients and employers shall have priority over transactions in securities or other investments in which a member is the beneficial owner so that such personal transactions do not operate adversely to clients' or employers' interests. If members make a recommendation regarding the purchase or sale of a security or other investment, they shall give their clients and employer adequate opportunity to act on their recommendations before acting on their own behalf.

For purposes of the Code and Standards, a member is a "beneficial owner" if the member has:

  • A direct or indirect pecuniary interest in the securities.
  • The power to vote or direct the voting of the shares of the securities or investments.
  • The power to dispose or direct the disposition of the security or investment.

This standard applies to all access persons. Personal transactions include those made for your own accounts, family accounts, and accounts in which the member has a direct or indirect pecuniary interest. Note that family accounts that are also client accounts should be treated like any other firm accounts. Neither special treatment nor disadvantage should be given to such accounts.

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B. Priority of transactions
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
Procedures for compliance

You should encourage your firm to prepare and distribute a Code of Ethics and compliance procedures, applicable to principals and employees, emphasizing their obligation to placing the interests of clients above personal and employer interests. The form and content of such compliance procedures depend on the size and nature of each organization and the laws to which it is subject. In general, however, the code and procedures should do the following:

  • Limited participation in equity IPOs.
    Members and candidates should not benefit from the position that their clients occupy in the marketplace - through preferred trading, the allocation of limited offerings, and/or oversubscription.

  • Restriction on private placements.
    As participants in private placements have an incentive to recommend these investments to clients, members and candidates should not be involved in these transactions, which could be perceived as favors or gifts designed to influence future judgment or to reward past business deals.

  • Establish blackout/ restricted periods.
    Managers or employees involved in the investment decision-making process should be prevented from initiating trades in a security for which their firms have a pending "buy" or "sell" order within a specific period before the order is executed or cancelled. They should not be allowed to do "front running."

  • Reporting requirements.

    • Disclosure of holdings in which the employee has a beneficial interest.
    • Providing duplicate confirmations of transactions. Investment professionals should ask their brokers to supply duplicate copies to their firms of all their personal securities transactions and copies of periodic statements.
    • Pre-clearance procedures. Investment professionals should clear all personal investments, to identify possible conflicts before the execution of personal trades.

  • Disclosure of policies.

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B. Priority of transactions
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
Example 1

You receive a news release that a small firm in the industry that you follow has obtained a major contract with a multinational firm. The contract will double sales for the small firm. You note that the small firm's stock price has already increased from $12 to $13. You immediately submit an order to buy 1,000 shares. After your order is confirmed, you send an email advisory to all clients summarizing the news and suggesting that this is a buying opportunity. This is a clear violation of this standard. Clients had no opportunity to act on this information prior to your personal trading.

Example 2

An analyst tells her father about a tender offer. She does not trade for her client until her father has made the trade. She violates this standard by placing her father's interest above her clients'.

Example 3

An analyst maintains an account in his wife's maiden name at another firm. Using that account, he often buys hot issues in which his clients cannot participate. He violates the standard by trading for his wife before his clients can acquire shares. He also should disclose the trading for the account in his wife's name to his employer.

Example 4

David is a portfolio manager. He manages the retirement account established with the firm by his parents. David does not trade for this account until all other accounts are traded. He violates this standard by discriminating against his parents' account. As fee-paying clients to the firm, his parents should be treated the same as any other clients.

Example 5

A member manages a portfolio of 20 clients. Included in this portfolio is the portfolio of a family member. The member may NOT first allocate transactions to all the other clients in the portfolio and then only to the family member, as this would be unfairly prejudiced against the family member. The family member's account must be treated like a normal client account.

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C. Referral Fees.
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
C. Referral Fees.

You must disclose to your employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received by or paid to others for the recommendation of products or services.

Such disclosure should help the client evaluate any possible partiality shown in any recommendations of services as well as evaluate the full cost of services.

You are required to:

  • Disclose the existence and terms of any referral fee agreements to all clients or prospects who have been referred under such agreements.
  • Describe the nature of the consideration and its estimated dollar value in this disclosure. Consideration includes all fees, whether paid or not (in cash, in soft dollars, or in kind).
  • Consult a supervisor and legal counsel concerning any prospective arrangement regarding referral fees.

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C. Referral Fees.
#analyst-notes #and-actions #code-of-ethics-and-standards-of-professional-conduct #vi-conflicts-of-interest
Example 1

You provide investment counseling on a fee-for-services basis. You encourage all of your clients to place trades through a particular broker: Richard Jones. You have known Mr. Jones for many years and feel that he is an excellent broker with fees and services that are competitive for the type of clients you typically work with. Mr. Jones also provides you with a "finder's fee" for each client you refer to him. Even if the services recommended are reasonable and appropriate, you must still disclose the referral fee.

Example 2

ABC Firm has an agreement with XYZ Firm that ABC will recommend prospective pension clients to XYZ and in return XYZ will give ABC free research. ABC does not disclose the arrangement to prospective clients. ABC violates this standard for not disclosing the arrangement to prospective clients.

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A. Conduct as Members and Candidates in the CFA Program.
#vii-responsibilities-as-a-cfa-institute-member-or-cfa-candidate

A. Conduct as Members and Candidates in the CFA Program.


You must not engage in any conduct that compromises the reputation or integrity of CFA Institute or the CFA designation or the integrity, validity, or security of the CFA examinations.

This standard applies to anyone who cheats, or helps other people to cheat, on the CFA examination or any other examination. Improperly using the CFA designation is also prohibited by this standard.

Example

Melissa White, CFA, runs her own investment advisory firm and serves as a proctor for the administration of the CFA examination in her city. She receives copies of the Level II CFA examination many days before the exam day. On the evening prior to the exam, she provides information concerning the examination questions to two stressed candidates whom are also her best-performing advisors.

White and the two candidates violated the standard. Although it does not involve clients' money or an investment recommendation, White and the two members undermined the integrity and validity of the examination.

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