Last week, we talked about the importance of the Ethics & Standards topic area across all three CFA exams. Its importance in the CFA level 1 exam is heightened by the fact that new candidates may not know what they are up against within the topic.
Reading through the Code & Standards can seem obvious and many CFA candidates believe their moral compass will guide them to the most obvious answer on the exam. When they get to the exam, they’re surprised by the level of ambiguity in the questions and cannot decide between two seemingly correct and ethical answers.
We started working through a few ethics questions last week but will continue this week with five more. It is extremely important that you study these questions and the ones in the curriculum to learn how the CFA Institute asks questions within the Ethics topic and how it expects you to answer.
CFA Ethics Question #1
Roberts is in charge of a group of analysts at BB&T, only some of which are CFA charterholders or candidates. For a large project, he is delegating some of his supervisory duties to one of the analysts to lead the group. What are his responsibilities under the Code and Standards if he delegates tasks to the group.
A. His responsibilities under the Code and Standards apply to conduct of those with CFA designations but not to those that are not subject to the code. For those employees, only legal obligations apply.
B. He is no longer responsible for the group’s conduct because he delegated supervisory duties. That person is now responsible.
C. He is still responsible for all the analysts’ conduct under the Code and Standards.
Under Standard IV, Responsibilities of Supervisors, someone bound by the Code and Standards may delegate supervisory responsibilities but is still accountable for all actions of subordinates. Further, a supervisor is responsible to the Code and Standards for all actions whether their subordinates are bound by the Standards or not.
CFA Ethics Question #2
Babbitt & Coolidge Investments (B&C) has been hired to manage a follow-on issuance of shares for Argon Tech. The brokerage unit of B&C has a sell recommendation on Argon Tech but some fundamentals have improved and a review of the analysis is due. The head of the investment banking division has asked the reviewing analyst to look at the new information and upgrade the shares to buy. According to the Standards, what may the brokerage unit do?
A. Increase the recommendation but only to a hold since it is still a conservative recommendation
B. Place the company on a restricted list and only offer factual information in the report
C. Assign a new analyst that is willing to take the new information into account and assign a buy rating
Under Standard I, Independence and Objectivity, the firm should discontinue issuing recommendations on the stock to avoid the appearance of a conflict. Analysts must refuse any requests to change recommendations even if the change is only to a slightly higher recommendation. Changing the analyst assigned to the stock does not eliminate the conflict of interest.
CFA Ethics Question #3
Tye is an analyst for Buckmaster & Walters and is about to make a new recommendation. According to the Standards, which actions will help ensure fair treatment of brokerage clients?
A. Inform everyone in advance that a recommendation is about to be made so everyone can be ready
B. Since institutional clients need more time to review for suitability under their plans, they should receive the information before individual accounts
C. Time between the decision and dissemination of the recommendation should be reduced
The question deals with Standard III, Fair Dealing. Answer A may allow the recommendation to be leaked out since more people know about the coming release. Firms should limit the number of people that know a new recommendation release is eminent. Answer B is a clear violation as it discriminates between clients by size and assets. Reducing the time between the decision and dissemination of the recommendation helps to avoid it being leaked ahead of the release.
CFA Ethics Question #4
Portfolio Manager Jacob has done very well and one of his clients wants to keep the manager motivated. The client promises to compensate Jacob, above what the firm is paying him, if he can continue to beat the index each year. Jacob is a CFA charterholder and should:
A. Turn down the extra compensation because it could create a conflict with performance on other accounts
B. Turn down the extra compensation because it could lead him to unethical behavior by incentivizing the outperformance
C. Get written permission from his employer prior to accepting the agreement for extra compensation
Standard IV, additional compensation arrangements, does not prohibit compensation beyond that made by an employee’s firm. The employee is still bound by the Code and Standards to not let the additional compensation interfere with fair dealing among accounts and other ethical behavior but may accept additional compensation if it is disclosed and approval is granted in writing by the firm.
CFA Ethics Question #5
Redbeard, an advisor and CFA charterholder, recommends his client invests in U.S. Treasury bonds. The client accepts the advice based on two statements made by Redbeard.
I) The default risk on U.S. Treasuries is effectively zero since the bonds are backed by the U.S. government
II) Based on the historical return to U.S. Treasuries over the last twenty years, you are guaranteed to earn at least 5% over the next several years.
Did Redbeard violate the CFA Code and Standards with either statement?
A. Neither statement is a violation
B. Only statement I is a violation of the Code and Standards
C. Only statement II is a violation of the Code and Standards
Standard I, misrepresentation, requires that all those bound by the Code and Standards separate fact from opinion. The first statement is a fact given the government’s backing of the bonds. The second statement is an opinion based on historical performance and what the advisor thinks will happen in the future. Guarantees of future returns must not be made unless they are contractual within the investment.
Did any of these Code and Standards questions stump you? For the ones you missed, make sure you go back through the question and really understand the CFA Institute’s way of thinking. Don’t forget to review those questions where you guessed correctly. Working as many ethics questions from the curriculum is critical to learning how to answer the questions on the exams. We’ll cover a few more next week before moving on to other topics for the December CFA exam.
‘til next time, happy studyin’
Joseph Hogue, CFA