Max Points on Ethics and the Standards

If you’ve been reading the blog for any length of time, you are probably tired of me repeating the importance of the ethics topic area on the exams. If you are new to the blog…get used to it because the material is integral to your success.
Over the three years, the Ethics and Standards (including miscellaneous material included) is worth about 12% of your entire CFA preparation. Beyond the points associated, the Institute has explicitly noted that your score on this portion of the exam will determine a pass/fail if your score is close to the minimum passing score. It’s the tie-breaker!
The biggest hurdle for candidates is realizing that while they may be ethical people, they still need to put in the study time to learn how to react in specific situations. The test developers are masters at dreaming up difficult scenarios where a rational person would consider two of the answers as correct. The only way to learn how to answer these questions is by practicing the examples at the end of the chapters and through question banks.
Fortunately, the material in the topic is virtually the same through each level (except for a few readings on additional topics on which you may or may not see questions). This means that hard work spent in level I will pay off over the next two years as well.

Professional Conduct Program (PCP)

There are a few key points that you need to remember of the PCP. Understand that information can come from four sources: self-disclosure, written complaints, media/public, or the exam proctors. Only members and candidates are subject to the PCP and the Code or Standards. Note that a charterholder supervisor is responsible under the PCP/Code for actions of non-charterholder subordinates.
Remember the basic process to an inquiry as well:
1)    Inquiry assigned to staff who collects information and determines one of three outcomes

  1. No sanction required
  2. Cautionary letter
  3. Inquiry escalates to next level

2)    The member can accept or contest this outcome and request the issue go to a panel

SPAMED: Components of the Code

While the acronym SPAMED makes it easier to remember the components, it is really the details within the code and standards that you will need to understand to answer exam questions.

  • Subordinate personal interests
  • Promote the integrity of and uphold rules governing capital markets
  • Act with integrity, competence, diligence and respect
  • Maintain and improve professional competence
  • Exercise reasonable care and independent judgment
  • Demonstrate ethical practice and professionalism

I’ve copied my own notes on the standards below. Three pages is about as condensed as you can make the material. These are the bird’s eye-view of the important concepts within each standard.

Standard I- Professionalism

**Strict law rule– the standards say to follow the most strict interpretation between either local laws or the code/standards. This applies to all jurisdictions to which you are responsible. A classic example is doing business in one country but living in another. You are probably under both jurisdictions so must follow ‘most strict’ laws in either of the two (or the code/standards).
Know or should have Known- must not knowingly violate or assist someone else in violating laws or code. A big part here (and with supervisor duties) is if you should have known, given your responsibilities.
*NOT required to inform police unless explicitly required by law. Procedure is to inform supervisor, compliance and to disassociate from activities.
Independence & Objectivity
* Firms/analysts should pay their own expenses whenever possible and disclose when they have accepted any form of compensation. This includes when there is not a violation but may be a perception of a violation. Token gifts are acceptable but the Institute does not explicitly define or give a dollar amount on ‘Token’ so questions
* Issuer Paid research should be on a fee-only basis and not tied to rating. Issuer paid research must be disclosed.
* You need to understand and tell the difference between informational firewalls, quiet (blackout) periods, and restricted lists.
Misrepresentation
You can NEVER guarantee a return unless the investment is explicitly guaranteed by an institution (and the institution has the means to back up losses, i.e. U.S. Government).
All informational sources must be directly credited (not just- “leading analysts” or “experts”).
Misconduct
* Even if something is legal (drinking) members/candidates must not engage in the activity if it could lead to a loss of confidence in the employee, employer, profession or the Institute. Having a ‘high tolerance’ for alcohol does not cover the fact that the perception of misconduct may occur.
* Bankruptcy or civil disobedience is ok as long as it is not from fraudulent conduct.

Standard II- Integrity of Capital Markets

Material non-public Information- This is a big one for the industry and the Institute
* know the Mosaic theory and how it is interpreted. Combination of material PUBLIC information with non-material non-public information is ok to trade on.
* members/candidates must not use or cause others to use material non-public information. “Material” is anything that an investor would want to know or could affect the asset price.
* Company conference calls or meetings are NOT public release and any material information divulged should be immediately made public (and cannot be traded on until made public)
Market Manipulation-
Any actions with INTENT to distort price or volume is against standards. Understand the “pump and dump” and “liquidity priming” scenarios

Standard III- Duties to Clients

Benefit of clients always comes before employer (whose benefit is before employee)
Understand responsibilities for ‘best execution’ and that ultimate beneficiary (i.e. pension holder) is your client, not necessarily the institution hiring your firm
Fair Dealing
* All clients must be treated fairly and equally
Different service levels are ok, but must be available to everyone and disclosed
Allocations should be on a pro-rated policy (but only to those portfolios where suitable)
The method of client communication seems to be important. Example: you can’t send snail mail to some while directly calling others because this gives the called clients an unfair advantage. You can however use the same initial distribution method (email everyone) then start calling clients without violating standards.
Suitability
You must understand client’s risk/return objectives and constraints to determine suitability. Investments may be risky in isolation, but suitable given total portfolio.
Performance Presentation
Just remember FACT: Fair, Accurate, Complete (and timely)
Confidentiality
Only release client information if: required by law, illegal activities, or explicit client permission

Standard IV- Duties to Employers

Loyalty
Remember benefit should be to (in order): client, employer, then yourself
* Must NOT take any records, files, or property from employer when leaving. You can reconstruct client information, but only from memory
* You can make preparations for another job (before leaving employer) but only on your own time and it must not conflict with employer until after you have formally left their employment.
Additional Compensation
*** Written Consent (not verbal!) must be obtained from ALL parties (employer and third parties) prior to accepting additional compensation that could create a conflict with employer
Responsibilities of Supervisors
This is a confusing one for many candidates because a lot falls under the ‘should have known’ category. **Understand that supervisors should have policies in place that help prevent or detect violations
*Inform IN WRITING if the company has an insufficient compliance system and decline your supervisory position if the company fails to improve compliance.
* Even if employees are not members/candidates, a charterholder supervisor is responsible under the Code and Standards for their actions.

Standard V- Investment Analysis, Recommendations, and Actions

Diligence and Reasonable Basis
* a big part of this is relying on second or third-party information ONLY if you can confirm the validity and reliability of their research
– You do not need to disassociate from a recommendation (of which you do not agree) made in a group if the recommendation has a reasonable basis but you should document your disagreement.
Communication with Clients and Prospective Clients
* big issue here is distinguishing between FACT and OPINION in analysis.
* communications must include basic factors and processes used in investment analysis/selection. This does not mean a lengthy discussion but a general statement on how investments are selected.
Record Retention
Keep all records on analysis/recommendates for SEVEN (7) years
Records are property of employer so it is their responsibility to keep them if you leave

Standard VI- Conflicts of Interest

* Important that disclosures are made for actual and POTENTIAL conflicts
-Disclose any material ownership. The Institute does not put a dollar amount but it is usually fairly obvious. Ownership is personal or anyone living in same household (but not family living outside of household).
Priority of Transactions
– Again, priority is for: Client, Employer, then self (beneficial ownership)
“Family” or beneficial ownership is only those residing with you. Other family, not living with you, should be treated same as other clients
– Oversubscribed IPO should be pro-rated to clients first
Referral Fees
Any compensation or benefit must be disclosed (must include nature of benefit)
– Issue here is usually when there is obvious connection between yourself and who you are referring. Example: you are referring services offered by other departments at your company

Standard VII- Responsibilities of members and candidates

This always seemed the catch-all for stuff not covered by other standards.
* Focus seems to be on candidate obligation to the standards (don’t cheat on the exams)
– Members can disagree with Institute and express differing opinions but must not do something that compromises reputation of the Institute or the designation
Reference to the Institute, designation, and program
– Designation (CFA) can only be attached to a person, not a company
– You must pay dues and sign annual standards compliance to use designation
As mentioned, you can read through and memorize the material for the code and standards but it may still not help as much as working through practice problems. You really need to work through specific scenarios to see how these standards are applied. Give the curriculum a read and then focus on key points like the ones noted above. Then spend your time working through questions to get a good feel for it.
Ten weeks to the exam. Almost there just stay focused and you’ll make it.
‘til next time, happy studyin’
Joseph Hogue, CFA

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