We’ve covered eight practice problems in the CFA Level 1 ethics material over two prior posts, available by clicking CFA Level 1 Ethics and CFA Level 1 Ethics Practice. This post will wrap up our practice problem review and look at a few key points to the Ethics and Standards topic area.
At the very least, you need to cover every end-of-chapter question in the Ethics study sessions at least once during your CFA exam prep. You may also want to consider a question bank of item sets as well to get a little more practice. The Ethical & Professional Standards topic area accounts for 15% of your CFA level 1 score.
Not only will you need to master the material for the exam, you’ll see it again in the CFA level 2 and level 3 exams where it’s worth as much as 15% of your score on each. The fact that you could see questions on all three exams covering roughly the same material makes for a great opportunity. Learn the material early in level 1 and you will save a lot of study time leading up to the other exams.
CFA Level 1 Ethics Practice Problem Review
We’ll work two more practice problems in this post. Be sure to check out the prior two posts for eight more ethics practice problems. When you’re working the problems, make sure you read through the given answer to get an understanding for how the CFA Institute is looking at the ethical dilemmas.
CFA Ethics Question #1
Tom Hart works for IAM Investment Management, a struggling firm that is likely to close soon under the weight of redemptions. Tom wants to start a small independent practice so he will have something to work on if the firm closes. Which of the following statements is correct under the Code and Standards?
A. CFA Institute members and candidates are prohibited from pursuing independent practice that might be in competition with their employer.
B. Tom needs to obtain written consent from his employer for the independent practice since it could result in compensation or other benefits in competition with the firm.
C. Since the firm is likely to close, Tom does not need permission from his employer and can start his independent practice. He must disclose his independent practice only when he starts making money.
CFA Ethics Question #2
Meg and June have been good friends since high school and are sitting down to a cup of coffee. Meg, the CFO of a large retail clothing chain, mentions that sales are booming and the quarterly results should look very good. June, an investment adviser, writes a research report to clients suggesting they buy shares of a retail exchange traded fund on the potential for high industry sales this quarter. June also buys shares of the fund, which includes shares of Meg’s company, for her personal account.
A. June violated the Code and Standards by buying shares of the fund but not by making the recommendation to clients.
B. June did not violate the Code and Standards by either action because she did not directly act on the information by buying shares of Meg’s company.
C. June violated the Code and Standards by both actions, buying shares of the fund and recommending that clients do so.
Question #1 Answer: B
Under Standard IV – loyalty, members and candidates may undertake independent practice as long as they get written permission from their employer. The requirement is not contingent on actual compensation or benefits but the potential. This is like the ‘perception of conflict’ standard held by the Institute. All necessary disclosures and requirements must be upheld if there is the potential or perception of conflict in a scenario.
Question #2 Answer: C
June violated Standard II – material non-public information because both her purchase and recommendation appears directly related to the information she received from Meg. The information would likely influence the share price of the fund¸ making it material, and it is non-public because it has not yet been released.
Wrap-up of CFA Level 1 Ethics Practice
Many of the ethics questions on the exams will offer one answer that the action was not a violation and then two questions that claim a violation but for different reasons. For this reason, you not only have to know if an action is a violation of the Code and Standards but also why it is a violation. Practicing ethics problems will help to practice matching violations to specific Standards.
Another favorite of the CFA Institute is the problem where someone makes two statements and the candidate must decide whether one, both or neither statement is a violation of the Code and Standards. One statement is usually clearly a violation or not but the other is often ambiguous. For these, you really need to study the Standards for claims that can be made and things you can say.
The ethics material on the CFA exams is actually not too difficult if you spend a little extra time studying before the first exam. I earned 70% + on the topic in the second and third exam without spending a lot of time refreshing just because I drilled on the material extensively while studying for the first exam. Do the same and you shouldn’t have any problems.
‘til next time, happy studyin’
Joseph Hogue, CFA