CFA Level 2 Schweser Book 1 Ethical and Professional Standards Quantitative Methods and Economics

http://www.freeaccountingbooks.com/cfa-level-2-schweser-book-1-ethical-and-professional-standards-quantitative-methods-and-economics/

BOOK I ETHICAL AND PROFESSIONAL

STANDARDS, QUANTITATIVE METHODS,

AND ECONOMICS

Readings and Learning Outcome Statements vii

Study Session 1 - Ethical and Professional Standards 1

Study Session 2 - Ethical and Professional Standards: Application 90

Self-Test - Ethical and Professional Standards 101

Study Session 3 - Quantitative Methods for Valuation........................................ 111

Self-Test - Quantitative Methods for Valuation 240

Study Session 4 - Economics for Valuation 246

Self-Test - Economics for Valuation 324

Formulas 329

Appendices 334

Index 339

SCHWESERNOTESTM 2016 LEVEL II CFA® BOOK 1: ETHICAL AND

PROFESSIONAL STANDARDS, QUANTITATIVE METHODS, AND

ECONOMICS

Published in 2015 by Kaplan, Inc.

Printed in the United States of America.

ISBN: 978-1-4754-3529-0

PPN: 3200-6841

If this book does not have the hologram with the Kaplan Schweser logo on the back cover, it was

distributed without permission of Kaplan Schweser, a Division of Kaplan, Inc., and is in direct violation

of global copyright laws. Your assistance in pursuing potential violators of this law is greatly appreciated.

Required CFA Institute disclaimer: "CFA Institute does not endorse, promote, or warrant the accuracy

or quality of the products or services offered by Kaplan Schweser. CFA® and Chartered Financial

Analyst® are trademarks owned by CFA Institute."

Certain materials contained within this text are the copyrighted property of CFA Institute. The

following is the copyright disclosure for these materials: "Copyright, 2015, CFA Institute. Reproduced

and republished from 2016 Learning Outcome Statements, Level I, II, and III questions from CFA®

Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute's Global

These materials may not be copied without written permission from the author. The unauthorized

duplication of these notes is a violation of global copyright laws and the CFA Institute Code of Ethics.

Your assistance in pursuing potential violators of this law is greatly appreciated.

Disclaimer: The Schweser Notes should be used in conjunction with the original readings as set forth

by CFA Institute in their 2016 Level II CFA Study Guide. The information contained in these Notes

covers topics contained in the readings referenced by CFA Institute and is believed to be accurate.

However, their accuracy cannot be guaranteed nor is any warranty conveyed as to your ultimate exam

success. The authors of the referenced readings have not endorsed or sponsored these Notes.

WELCOME TO THE 2016 LEVEL II

SCHW"ESERN OTES™

Thank you for trusting Kaplan Schweser to help you reach your goals. We are pleased

that you have chosen us to help you prepare for the Level II CFA Exam. In this

introduction, I want to explain the resources included with these SchweserNotes, suggest

how you can best use Schweser materials to prepare for the exam, and direct you toward

other educational resources you will find helpful as you study for the exam.

Besides the SchweserNotes themselves, there are many educational resources available

at Schweser.com. Log in using the individual username and password that you received

when you purchased your SchweserNotes.

SchweserNotes ™

These notes consist of five volumes that include complete coverage of all 18 Study

Sessions and all Learning Outcome Statements (LOS) with examples, Concept Checkers

(multiple-choice questions for every topic review), and Challenge Problems for many

topic reviews to help you master the material and check your progress. At the end of

each major topic area, we include a Self-test. Self-test questions are created to be examlike

in format and difficulty, to help you evaluate how well your study of each topic has

prepared you for the actual exam.

Practice Questions

Studies have shown that to retain what you learn, it is important that you quiz yourself

often. For this purpose we offer SchweserPro TM QBank, which contains thousands of

Level II practice questions, item sets, and explanations. Questions are available for each

LOS, topic, and Study Session. Build your own quizzes by specifying the topics and

the number of questions. SchweserPro QBank is an essential learning aid for achieving

the depth of proficiency needed at Level II. It should not, however, be considered a

replacement for practicing "exam-type" questions as found in our Practice Exams,

Volumes 1 & 2 and our Schweser Mock Exam.

Practice Exams

Schweser offers six full 6-hour practice exams: Schweser Practice Exams Volume 1 and

Volume 2 each contain three complete 120-question exams. These are important tools

for gaining the speed and skills you will need to pass the exam. Each book contains

answers with full explanations for self-grading and evaluation. By entering your

answers at Schweser.com, you can use our Performance Tracker to find out how you are

performing compared to other Schweser Level II candidates.

Schweser Candidate Resource Library

We have created a number of online reference videos, which are available to all

purchasers of Schweser Premium Instruction and PremiumPlus packages. Schweser

Candidate Resource Library videos range from 20 to 60 minutes in length and cover

such topics as: "Introduction to Item Sets," "Hypothesis Testing," "Foreign Exchange

Basics," "Ratio Analysis," and "Forward Contracts."

Welcome to the 2016 Level II SchweserNotes™

Online Schweser Study Calendar

Select the date when you will start and what days of the week you can study, and the

online Schweser Study Calendar will create a study plan just for you, breaking each

study session into daily and weekly tasks to keep you on track and help you monitor

your progress through the curriculum.

How to Succeed

The Level II CFA exam is a formidable challenge (56 topic reviews and 469 Learning

Outcome Statements), and you must devote considerable time and effort to be properly

prepared. There is no shortcut! You must learn the material, know the terminology

and techniques, understand the concepts, and be able to answer 120 questions quickly

and mostly correctly. Fifteen hours per week for 25 weeks is a good estimate of the

study time required on average, but different candidates will need more or less time,

depending on their individual backgrounds and experience.

There are no shortcuts; the CFA Institute will test you in a way that will reveal how well

you know the Level II curriculum. You should begin early and stick to your study plan.

Read the SchweserNotes and complete the Concept Checkers and Challenge Problems

for each topic review. Prepare for and attend a live class, an online class, or a study group

each week. Take quizzes often using SchweserPro Qbank and go back to review previous

topics and Study Sessions regularly. At the end of each topic area, take the Self-test to

check your progress. You should finish reading the curriculum at least four weeks before

the Level II exam so that you have sufficient time for Practice Exams and for further

review of those topics that you have not yet mastered.

I would like to thank Kent Westlund, CFA Content Specialist, and Jared Heintz,

Production Project Manager, for their contributions to the 2016 Level II SchweserNotes

for the CFA Exam.

Best regards,

Dr. Bijesh Tolia, CFA, CA

VP of CFA Education and Level II Manager

Kaplan Schweser

READINGS AND

LEARNING OUTCOME STATEMENTS

READINGS

The following material is a review of the Ethical and Professional Standards, Quantitative

Methods, and Economics principles designed to address the learning outcome statements set

forth by CPA Institute.

STUDY SESSION 1

Reading Assignments

Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II

(CFA Institute, 2015)

1. Code of Ethics and Standards of Professional Conduct

2. Guidance for Standards I-VII

3. CFA Institute Research Objectivity Standards

page 1

page 80

STUDY SESSION 2

Reading Assignments

Ethical and Professional Standards, CFA Program Curriculum, Volume 1, Level II

(CFA Institute, 2015)

4. The Glenarm Company

5. Preston Partners

6. Super Selection

7. Trade Allocation: Fair Dealing and Disclosure

8. Changing Investment Objectives

page 90

page 92

page 95

page 98

page 100

STUDY SESSION 3

Reading Assignments

Quantitative Methods for Valuation, CFA Program Curriculum, Volume 1, Level II

(CFA Institute, 2015)

9. Correlation and Regression

10. Multiple Regression and Issues in Regression Analysis

11. Time-Series Analysis

12. Excerpt from "Probabilistic Approaches: Scenario Analysis,

Decision Trees, and Simulations"

page 111

page 146

page 194

page 231

STUDY SESSION 4

Reading Assignments

Economics for Valuation, CFA Program Curriculum, Volume 1, Level II

(CFA Institute, 2015)

13. Currency Exchange Rates: Determination and Forecasting

14. Economic Growth and the Investment Decision

15. Economics of Regulation

page 246

page 291

page 312

Book 1 - Ethical and Professional Standards, Quantitative Methods, and Economics

Readings and Learning Outcome Statements

LEARNING OUTCOME STATEMENTS (LOS)

The CPA Institute Learning Outcome Statements are listed below. These are repeated in each

topic review; however, the order may have been changed in order to get a better fit with the

flow of the review.

STUDY SESSION 1

The topical coverage corresponds with the following CPA Institute assigned reading:

1. CFA Institute Code of Ethics and Standards of Professional Conduct

The candidate should be able to:

a. describe the six components of the Code of Ethics and the seven Standards of

Professional Conduct. (page 1)

b. explain the ethical responsibilities required of CFA Institute members and

candidates in the CFA Program by the Code and Standards. (page 2)

The topical coverage corresponds with the following CPA Institute assigned reading:

2. Guidance for Standards I-VII

The candidate should be able to:

a. demonstrate a thorough knowledge of the Code of Ethics and Standards of

Professional Conduct by applying the Code and Standards to specific situations.

(page 5)

b. recommend practices and procedures designed to prevent violations of the Code

of Ethics and Standards of Professional Conduct. (page 5)

The topical coverage corresponds with the following CPA Institute assigned reading:

3. CFA Institute Research Objectivity Standards

The candidate should be able to:

a. explain the objectives of the Research Objectivity Standards. (page 80)

b. evaluate company policies and practices related to research objectivity, and

distinguish between changes required and changes recommended for compliance

with the Research Objectivity Standards. (page 81)

STUDY SESSION 2

The topical coverage corresponds with the following CPA Institute assigned reading:

4. The Glenarm Company

The candidate should be able to:

a. evaluate the practices and policies presented. (page 90)

b. explain the appropriate action to take in response to conduct that violates the

CFA Institute Code of Ethics and Standards of Professional Conduct. (page 90)

The topical coverage corresponds with the following CPA Institute assigned reading:

5. Preston Partners

The candidate should be able to:

a. evaluate the practices and policies presented. (page 92)

b. explain the appropriate action to take in response to conduct that violates the

CFA Institute Code of Ethics and Standards of Professional Conduct (page 92)

Book 1 - Ethical and Professional Standards, Quantitative Methods, and Economics

Readings and Learning Outcome Statements

The topical coverage corresponds with the following CPA Institute assigned reading:

6. Super Selection

The candidate should be able to:

a. evaluate the practices and policies presented. (page 95)

b. explain the appropriate action to take in response to conduct that violates the

CFA Institute Code of Ethics and Standards of Professional Conduct. (page 95)

The topical coverage corresponds with the following CPA Institute assigned reading:

7. Trade Allocation: Fair Dealing and Disclosure

The candidate should be able to:

a. evaluate trade allocation practices, and determine whether they comply with the

CFA Institute Standards of Professional Conduct addressing fair dealing and

client loyalty. (page 98)

b. describe appropriate actions to take in response to trade allocation practices that

do not adequately respect client interests. (page 99)

The topical coverage corresponds with the following CPA Institute assigned reading:

8. Changing Investment Objectives

The candidate should be able to:

a. evaluate the disclosure of investment objectives and basic policies, and determine

whether they comply with the CFA Institute Standards of Professional Conduct.

(page 100)

b. describe appropriate actions needed to ensure adequate disclosure of the

investment process. (page 100)

STUDY SESSION 3

The topical coverage corresponds with the following CPA Institute assigned reading:

9. Correlation and Regression

The candidate should be able to:

calculate and interpret a sample covariance and a sample correlation coefficient,

and interpret a scatter plot. (page 111)

b. describe limitations to correlation analysis. (page 115)

formulate a test of the hypothesis that the population correlation coefficient

equals zero and determine whether the hypothesis is rejected at a given level of

significance. (page 116)

d. distinguish between the dependent and independent variables in a linear

regression. (page 117)

describe the assumptions underlying linear regression and interpret regression

coefficients. (page 119)

calculate and interpret the standard error of estimate, the coefficient of

determination, and a confidence interval for a regression coefficient. (page 123)

g. formulate a null and alternative hypothesis about a population value of a

regression coefficient and determine the appropriate test statistic and whether

the null hypothesis is rejected at a given level of significance. (page 125)

h. calculate the predicted value for the dependent variable, given an estimated

regression model and a value for the independent variable. (page 126)

calculate and interpret a confidence interval for the predicted value of the

dependent variable. (page 126)

•

Book 1 - Ethical and Professional Standards, Quantitative Methods, and Economics

Readings and Learning Outcome Statements

describe the use of analysis of variance (ANOVA) in regression analysis, interpret

ANOVA results, and calculate and interpret the F-statistic. (page 128)

k. describe limitations of regression analysis. (page 133)

• J •

The topical coverage corresponds with the following CPA Institute assigned reading:

10. Multiple Regression and Issues in Regression Analysis

The candidate should be able to:

formulate a multiple regression equation to describe the relation between

a dependent variable and several independent variables and determine the

statistical significance of each independent variable. (page 147)

b. interpret estimated regression coefficients and their p-values. (page 148)

formulate a null and an alternative hypothesis about the population value of

a regression coefficient, calculate the value of the test statistic, and determine

whether to reject the null hypothesis at a given level of significance. (page 149)

d. interpret the results of hypothesis tests of regression coefficients. (page 149)

calculate and interpret 1) a confidence interval for the population value of a

regression coefficient and 2) a predicted value for the dependent variable, given

an estimated regression model and assumed values for the independent variables.

(page 153)

explain the assumptions of a multiple regression model. (page 155)

g. calculate and interpret the F-statistic, and describe how it is used in regression

analysis. (page 155)

h. distinguish between and interpret the R2 and adjusted R2 in multiple regression.

(page 157)

evaluate how well a regression model explains the dependent variable by

analyzing the output of the regression equation and an ANOVA table.

(page 159)

formulate a multiple regression equation by using dummy variables to

represent qualitative factors and interpret the coefficients and regression results.

(page 164)

k. explain the types of heteroskedasticity and how heteroskedasticity and serial

correlation affect statistical inference. (page 167)

describe multicollinearity and explain its causes and effects in regression analysis.

(page 174)

m. describe how model misspecification affects the results of a regression analysis

and describe how to avoid common forms of misspecification. (page 177)

n. describe models with qualitative dependent variables. (page 180)

o. evaluate and interpret a multiple regression model and its results. (page 181)

•

• J •

The topical coverage corresponds with the following CPA Institute assigned reading:

11. Time-Series Analysis

The candidate should be able to:

a. calculate and evaluate the predicted trend value for a time series, modeled as

either a linear trend or a log-linear trend, given the estimated trend coefficients.

(page 194)

b. describe factors that determine whether a linear or a log-linear trend should

be used with a particular time series and evaluate limitations of trend models.

(page 200)

c. explain the requirement for a time series to be covariance stationary and describe

the significance of a series that is not stationary. (page 201)

d. describe the structure of an autoregressive (AR) model of order p and calculate

one- and two-period-ahead forecasts given the estimated coefficients. (page 202)

explain how autocorrelations of the residuals can be used to test whether the

autoregressive model fits the time series. (page 203)

explain mean reversion and calculate a mean-reverting level. (page 204)

contrast in-sample and out-of-sample forecasts and compare the forecasting

accuracy of different time-series models based on the root mean squared error

criterion. (page 206)

h. explain the instability of coefficients of time-series models. (page 207)

describe characteristics of random walk processes and contrast them to

covariance stationary processes. (page 207)

describe implications of unit roots for time-series analysis, explain when unit

roots are likely to occur and how to test for them, and demonstrate how a time

series with a unit root can be transformed so it can be analyzed with an AR

model. (page 208)

k. describe the steps of the unit root test for nonstationarity and explain the

relation of the test to autoregressive time-series models. (page 208)

explain how to test and correct for seasonality in a time-series model and

calculate and interpret a forecasted value using an AR model with a seasonal lag.

(page 212)

m. explain autoregressive conditional heteroskedasticity (ARCH) and describe how

ARCH models can be applied to predict the variance of a time series. (page 216)

n. explain how time-series variables should be analyzed for nonstationarity and/or

cointegration before use in a linear regression. (page 217)

o. determine an appropriate time-series model to analyze a given investment

problem and justify that choice. (page 219)

•

• J •

Book 1- Ethicaland ProfessionalStandards,Quantitative Methods, and Economics

Readings and Learning Outcome Statements

The topical coverage corresponds with the following CPA Institute assigned reading:

12. Excerpt from "Probabilistic Approaches Scenario Analysis, Decision Trees,

and Simulations"

The candidate should be able to:

a. describe steps in running a simulation. (page 231)

b. explain three ways to define the probability distributions for a simulation's

variables. (page 231)

c. describe how to treat correlation across variables in a simulation. (page 231)

d. describe advantages of using simulations in decision making. (page 233)

e. describe some common constraints introduced into simulations. (page 234)

f. describe issues in using simulations in risk assessment. (page 235)

g. compare scenario analysis, decision trees, and simulations. (page 236)

STUDY SESSION 4

The topical coverage corresponds with the following CPA Institute assigned reading:

13. Currency Exchange Rates: Determination and Forecasting

The candidate should be able to:

a. calculate and interpret the bid-ask spread on a spot or forward foreign currency

quotation and describe the factors that affect the bid-offer spread. (page 246)

b. identify a triangular arbitrage opportunity and calculate its profit, given the bidoffer

quotations for three currencies. (page 247)

Book 1- Ethical and ProfessionalStandards, Quantitative Methods, and Economics

Readings and Learning Outcome Statements

distinguish between spot and forward rates and calculate the forward premium/

discount for a given currency. (page 252)

d. calculate the mark-to-market value of a forward contract. (page 253)

explain international parity relations (covered and uncovered interest rate parity,

purchasing power parity, and the international Fisher effect). (page 256)

describe relations among the international parity conditions. (page 262)

g. evaluate the use of the current spot rate, the forward rate, purchasing power

parity, and uncovered interest parity to forecast future spot exchange rates.

(page 263)

h. explain approaches to assessing the long-run fair value of an exchange rate.

(page 268)

describe the carry trade and its relation to uncovered interest rate parity and

calculate the profit from a carry trade. (page 269)

explain how flows in the balance of payment accounts affect currency exchange

rates. (page 264)

k. describe the Mundell-Fleming model, the monetary approach, and the asset

market (portfolio balance) approach to exchange rate determination. (page 271)

forecast the direction of the expected change in an exchange rate based on

balance of payment, Mundell-Fleming, monetary, and asset market approaches

to exchange rate determination. (page 271)

m. explain the potential effects of monetary and fiscal policy on exchange rates.

(page 271)

n. describe objectives of central bank intervention and capital controls and describe

the effectiveness of intervention and capital controls. (page 274)

o. describe warning signs of a currency crisis. (page 275)

p. describe uses of technical analysis in forecasting exchange rates. (page 275)

•

• J •

The topical coverage corresponds with the following CPA Institute assigned reading:

14. Economic Growth and the Investment Decision

The candidate should be able to:

compare factors favoring and limiting economic growth in developed and

developing economies. (page 291)

b. describe the relation between the long-run rate of stock market appreciation and

the sustainable growth rate of the economy. (page 292)

explain why potential GDP and its growth rate matter for equity and fixed

income investors. (page 293)

d. distinguish between capital deepening investment and technological progress

and explain how each affects economic growth and labor productivity.

(page 293)

forecast potential GDP based on growth accounting relations. (page 296)

explain how natural resources affect economic growth and evaluate the argument

that limited availability of natural resources constrains economic growth.

(page 297)

g. explain how demographics, immigration, and labor force participation affect the

rate and sustainability of economic growth. (page 298)

h. explain how investment in physical capital, human capital, and technological

development affects economic growth. (page 299)

compare classical growth theory, neoclassical growth theory, and endogenous

growth theory. (page 300)

explain and evaluate convergence hypotheses. (page 302)

•

• J •

Book 1 - Ethical and Professional Standards, Quantitative Methods, and Economics

Readings and Learning Outcome Statements

k. describe the economic rationale for governments to provide incentives to private

investment in technology and knowledge. (page 303)

1. describe the expected impact of removing trade barriers on capital investment

and profits, employment and wages, and growth in the economies involved.

(page 304)

The topical coverage corresponds with the following CPA Institute assigned reading:

15. Economics of Regulation

The candidate should be able to:

describe classifications of regulations and regulators. (page 312)

b. describe uses of self-regulation in financial markets. (page 313)

describe the economic rationale for regulatory intervention. (page 313)

d. describe regulatory interdependencies and their effects. (page 314)

describe tools of regulatory intervention in markets. (page 315)

explain purposes in regulating commerce and financial markets. (page 315)

g. describe anticompetitive behaviors targeted by antitrust laws globally and

evaluate the antitrust risk associated with a given business strategy. (page 317)

h. describe benefits and costs of regulation. (page 317)

evaluate how a specific regulation affects an industry, company, or security .

(page 318)

•

The following is a review of the Ethical and Professional Standards principles designed to address the learning

outcome statements set forth by CFA Institute. Cross-Reference to CFA Institute Assigned Reading #1.

CFA INSTITUTE CODE OF ETHICS AND

STANDARDS OF PROFESSIONAL CONDUCT

GUIDANCE FOR STANDARDS I VII

Study Session 1

EXAM Focus

In addition to reading this review of the ethics material, we strongly recommend that

all candidates for the CFA® examination read the Standards of Practice Handbook 11th

Edition (2014) multiple times. As a Level II CFA candidate, it is your responsibility to

comply with the Code and Standards. The complete Code and Standards are reprinted in

Volume 1 of the CFA Program Curriculum.

LOS l.a: Describe the six components of the Code of Ethics and the seven

Standards of Professional Conduct.

CFA® Program Curriculum, Volume 1, page 15

THE CODE OF ETHICS

Members of CFA Institute (including CFA charterholders) and candidates for the CFA

designation ("Members and Candidates") must: 1

• Act with integrity, competence, diligence, and respect, and in an ethical manner

with the public, clients, prospective clients, employers, employees, colleagues 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.

• 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 and viability of the global capital markets for the ultimate

benefit of society.

• Maintain and improve their professional competence and strive to maintain and

improve the competence of other investment professionals.

from Standards of Practice Handbook, 11th Ed., 2014, with permission from CFA Institute.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

THE STANDARDS OF PROFESSIONAL CONDUCT

I: Professionalism

II: Integrity of Capital Markets

III: Duties to Clients

IV: Duties to Employers

V: Investment Analysis, Recommendations, and Actions

VI: Conflicts of Interest

VII: Responsibilities as a CFA Institute Member or CFA Candidate

LOS l.b: Explain the ethical responsibilities required of CFA Institute

members and candidates in the CFA Program by the Code and Standards.

CFA® Program Curriculum, Volume 1, page 15

STANDARDS OF PROFESSIONAL CONDUCT2

I. PROFESSIONALISM

A. Knowledge of the Law. Members and Candidates must understand and

comply with all applicable laws, rules, and regulations (including the CFA

Institute Code of Ethics and Standards of Professional Conduct) of any

government, regulatory organization, licensing agency, or professional

association governing their professional activities. In the event of conflict,

Members and Candidates must comply with the more strict law, rule, or

regulation. Members and Candidates must not knowingly participate or assist

in and must dissociate from any violation of such laws, rules, or regulations.

B. Independence and Objectivity. Members and Candidates must use reasonable

care and judgment to achieve and maintain independence and objectivity in

their professional activities. Members and Candidates must not offer, solicit, or

accept any gift, benefit, compensation, or consideration that reasonably could

be expected to compromise their own or another's independence and

objectivity.

C. Misrepresentation. Members and Candidates must not knowingly make any

misrepresentations relating to investment analysis, recommendations, actions,

or other professional activities.

D. Misconduct. Members and Candidates must not engage in any professional

conduct involving dishonesty, fraud, or deceit or commit any act that reflects

adversely on their professional reputation, integrity, or competence.

II. INTEGRITY OF CAPITAL MARKETS

A. Material Nonpublic Information. Members and Candidates who possess

material nonpublic information that could affect the value of an investment

must not act or cause others to act on the information.

2. Ibid.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

B. Market Manipulation. Members and Candidates must not engage in practices

that distort prices or artificially inflate trading volume with the intent to

mislead market participants.

III. DUTIES TO CLIENTS

A. Loyalty, Prudence, and Care. Members and Candidates have a duty of loyalty

to their clients and must act with reasonable care and exercise prudent

judgment. Members and Candidates must act for the benefit of their clients

and place their clients' interests before their employer's or their own interests.

B. Fair Dealing. Members and Candidates must deal fairly and objectively with

all clients when providing investment analysis, making investment

recommendations, taking investment action, or engaging in other professional

• • • actrvines.

C. Suitability.

1. When Members and Candidates are in an advisory relationship with a

client, they must:

a. Make a reasonable inquiry into a client's or prospective clients'

investment experience, risk and return objectives, and financial

constraints prior to making any investment recommendation or taking

investment action and must reassess and update this information

regularly.

b. Determine that an investment is suitable to the client's financial

situation and consistent with the client's written objectives, mandates,

and constraints before making an investment recommendation or

taking investment action.

c. Judge the suitability of investments in the context of the client's total

portfolio.

2. When Members and Candidates are responsible for managing a portfolio to

a specific mandate, strategy, or style, they must make only investment

recommendations or take only investment actions that are consistent with

the stated objectives and constraints of the portfolio.

D. Performance Presentation. When communicating investment performance

information, Members or Candidates must make reasonable efforts to ensure

that it is fair, accurate, and complete.

E. Preservation of Confidentiality. Members and Candidates must keep

information about current, former, and prospective clients confidential unless:

1. The information concerns illegal activities on the part of the client or

prospective client,

2. Disclosure is required by law, or

3. The client or prospective client permits disclosure of the information.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

IV. DUTIES TO EMPLOYERS

A. Loyalty. In matters related to their employment, Members and Candidates

must act for the benefit of their employer and not deprive their employer of the

advantage of their skills and abilities, divulge confidential information, or

otherwise cause harm to their employer.

B. Additional Compensation Arrangements. Members and Candidates must not

accept gifts, benefits, compensation, or consideration that competes with or

might reasonably be expected to create a conflict of interest with their

employer's interest unless they obtain written consent from all parties involved.

C. Responsibilities of Supervisors. Members and Candidates must make

reasonable efforts to ensure that anyone subject to their supervision or

authority complies with applicable laws, rules, regulations, and the Code and

Standards.

V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTIONS

A. Diligence and Reasonable Basis. Members and Candidates must:

1. Exercise diligence, independence, and thoroughness in analyzing

investments, making investment recommendations, and taking investment

• actions.

2. Have a reasonable and adequate basis, supported by appropriate research

and investigation, for any investment analysis, recommendation, or action.

B. Communication with Clients and Prospective Clients. Members and

Candidates must:

1. Disclose to clients and prospective clients the basic format and general

principles of the investment processes they use to analyze investments,

select securities, and construct portfolios and must promptly disclose any

changes that might materially affect those processes.

2. Disclose to clients and prospective clients significant limitations and risks

associated with the investment process.

3. 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.

4. Distinguish between fact and opinion in the presentation of investment

analysis and recommendations.

C. Record Retention. Members and Candidates must develop and maintain

appropriate records to support their investment analysis, recommendations,

actions, and other investment-related communications with clients and

prospective clients.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

VI. CONFLICTS OF INTEREST

A. Disclosure of Conflicts. Members and Candidates must make full and fair

disclosure of all matters that could reasonably be expected to impair their

independence and objectivity or interfere with respective duties to their clients,

prospective clients, and employer. Members and Candidates must ensure that

such disclosures are prominent, are delivered in plain language, and

communicate the relevant information effectively.

B. Priority of Transactions. Investment transactions for clients and employers

must have priority over investment transactions in which a Member or

Candidate is the beneficial owner.

C. Referral Fees. Members and Candidates must disclose to their 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.

VII. RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR CFA

CANDIDATE

A. Conduct as Participants in CFA Institute Programs. Members and Candidates

must not engage in any conduct that compromises the reputation or integrity

ofCFA Institute or the CFA designation or the integrity, validity, or security of

CFA Institute programs.

B. Reference to CFA Institute, the CFA Designation, and the CFA Program.

When referring to CFA Institute, CFA Institute membership, the CFA

designation, or candidacy in the CFA Program, Members and Candidates must

not misrepresent or exaggerate the meaning or implications of membership in

CFA Institute, holding the CFA designation, or candidacy in the CFA

Program.

LOS 2.a: Demonstrate a thorough knowledge of the Code of Ethics and

Standards of Professional Conduct by applying the Code and Standards to

specific situations.

LOS 2.b: Recommend practices and procedures designed to prevent

violations of the Code of Ethics and Standards of Professional Conduct.

CFA® Program Curriculum, Volume 1, page 21

I Professionalism

I(A) Knowledge of the Law. Members and Candidates must understand and

comply with all applicable laws, rules, and regulations (including the CFA Institute

Code of Ethics and Standards of Professional Conduct) of any government, regulatory

organization, licensing agency, or professional association governing their professional

activities. In the event of conflict, Members and Candidates must comply with the

more strict law, rule, or regulation. Members and Candidates must not knowingly

participate or assist in and must dissociate from any violation of such laws, rules, or

regulatio ns.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

- Professor'sNote: While we use the term "members" in the following, note that all

of the Standards apply to candidates as well. .. ~

Guidance-Code and Standards vs. Local Law

Members must know the laws and regulations relating to their professional activities in

all countries in which they conduct business. Members must comply with applicable

laws and regulations relating to their professional activity. Do not violate Code or

Standards even if the activity is otherwise legal. Always adhere to the most strict rules

and requirements (law or CFA Institute Standards) that apply.

Guidance-Participation or Association With Violations by Others

Members should dissociate, or separate themselves, from any ongoing client or employee

activity that is illegal or unethical, even if it involves leaving an employer (an extreme

case). While a member may confront the involved individual first, he must approach

his supervisor or compliance department. Inaction with continued association may be

construed as knowing participation.

Recommended Procedures for Compliance-Members

• Members should have procedures to keep up with changes in applicable laws, rules,

and regulations.

• Compliance procedures should be reviewed on an ongoing basis to ensure that they

address current law, CFAI Standards, and regulations.

• Members should maintain current reference materials for employees to access in

order to keep up to date on laws, rules, and regulations.

• Members should seek advice of counselor their compliance department when in

doubt.

• Members should document any violations when they disassociate themselves from

prohibited activity and encourage their employers to bring an end to such activity.

• There is no requirement under the Standards to report violations to governmental

authorities, but this may be advisable in some circumstances and required by law in

others.

• Members are strongly encouraged to report other members' violations of the Code

and Standards.

Recommended Procedures for Compliance-Firms

Members should encourage their firms to:

• Develop and/or adopt a code of ethics.

• Make available to employees information that highlights applicable laws and

regulations.

• Establish written procedures for reporting suspected violation of laws, regulations, or

company policies.

Members who supervise the creation and maintenance of investment services and

products should be aware of and comply with the regulations and laws regarding such

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

services and products both in their country of origin and the countries where they will

be sold.

Application of Standard I(A) Knowledge of the LauP

Example 1:

Michael Allen works for a brokerage firm and is responsible for an underwriting of

securities. A company official gives Allen information indicating that the financial

statements Allen filed with the regulator overstate the issuer's earnings. Allen seeks the

advice of the brokerage firm's general counsel, who states that it would be difficult for

the regulator to prove that Allen has been involved in any wrongdoing.

Comment:

Although it is recommended that members and candidates seek the advice of legal

counsel, the reliance on such advice does not absolve a member or candidate from the

requirement to comply with the law or regulation. Allen should report this situation to

his supervisor, seek an independent legal opinion, and determine whether the regulator

should be notified of the error.

Example 2:

Kamisha Washington's firm advertises its past performance record by showing the 10-

year return of a composite of its client accounts. However, Washington discovers that the

composite omits the performance of accounts that have left the firm during the 10-year

period and that this omission has led to an inflated performance figure. Washington

is asked to use promotional material that includes the erroneous performance number

when soliciting business for the firm.

Comment:

Misrepresenting performance is a violation of the Code and Standards. Although she did

not calculate the performance herself, Washington would be assisting in violating this

standard if she were to use the inflated performance number when soliciting clients. She

must dissociate herself from the activity. She can bring the misleading number to the

attention of the person responsible for calculating performance, her supervisor, or the

compliance department at her firm. If her firm is unwilling to recalculate performance,

she must refrain from using the misleading promotional material and should notify

the firm of her reasons. If the firm insists that she use the material, she should consider

whether her obligation to dissociate from the activity would require her to seek other

employment.

Example 3:

An employee of an investment bank is working on an underwriting and finds out the

issuer has altered their financial statements to hide operating losses in one division.

These misstated data are included in a preliminary prospectus that has already been

released.

Comment:

The employee should report the problem to his supervisors. If the firm doesn't get the

misstatement fixed, the employee should dissociate from the underwriting and, further,

3. Ibid.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

seek legal advice about whether he should undertake additional reporting or other

• acnons.

Example 4:

Laura Jameson, a U.S. citizen, works for an investment advisor based in the United

States and works in a country where investment managers are prohibited from

participating in IPOs for their own accounts.

Comment:

Jameson must comply with the strictest requirements among U.S. law (where her firm

is based), the CFA Institute Code and Standards, and the laws of the country where she

is doing business. In this case that means she must not participate in any IPOs for her

personal account.

Example 5:

A junior portfolio manager suspects that a broker responsible for new business from

a foreign country is being allocated a portion of the firm's payments for third-party

research and suspects that no research is being provided. He believes that the research

payments may be inappropriate and unethical.

Comment:

He should follow his firm's procedures for reporting possible unethical behavior and try

to get better disclosure of the nature of these payments and any research that is being

provided.

I(B) Independence and Objectivity. Members and Candidates must use reasonable

care and judgment to achieve and maintain independence and objectivity in their

professional activities. Members and Candidates must not offer, solicit, or accept any

gift, benefit, compensation, or consideration that reasonably could be expected to

compromise their own or another's independence and objectivity.

Guidance

Do not let the investment process be influenced by any external sources. Modest gifts

are permitted. Allocation of shares in oversubscribed IPOs to personal accounts is

NOT permitted. Distinguish between gifts from clients and gifts from entities seeking

influence to the detriment of the client. Gifts must be disclosed to the member's

employer in any case, either prior to acceptance if possible, or subsequently.

Guidance-Investment Banking Relationships

Do not be pressured by sell-side firms to issue favorable research on current or

prospective investment-banking clients. It is appropriate to have analysts work with

investment bankers in "road shows" only when the conflicts are adequately and

effectively managed and disclosed. Be sure there are effective "firewalls" between

research/investment management and investment banking activities.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Guidance-Public Companies

Analysts should not be pressured to issue favorable research by the companies they

follow. Do not confine research to discussions with company management, but rather

use a variety of sources, including suppliers, customers, and competitors.

Guidance-Buy-Side Clients

Buy-side clients may try to pressure sell-side analysts. Portfolio managers may have large

positions in a particular security, and a rating downgrade may have an effect on the

portfolio performance. As a portfolio manager, there is a responsibility to respect and

foster intellectual honesty of sell-side research.

Guidance-Fund Manager and Custodial Relationships

Members responsible for selecting outside managers should not accept gifts,

entertainment, or travel that might be perceived as impairing their objectivity.

Guidance-Performance Measurement and Attribution

Performance analysts may experience pressure from investment managers who have

produced poor results or acted outside their mandate. Members and candidates who

analyze performance must not let such influences affect their analysis.

Guidance-Manager Selection

Members and candidates must exercise independence and objectivity when they select

investment managers. They should not accept gifts or other compensation that could

be seen as influencing their hiring decisions, nor should they offer compensation

when seeking to be hired as investment managers. The responsibility to maintain

independence and objectivity applies to all a member or candidate's hiring and firing

decisions, not just those that involve investment management.

Guidance-Credit Rating Agencies

Members employed by credit rating firms should make sure that procedures prevent

undue influence by the firm issuing the securities. Members who use credit ratings

should be aware of this potential conflict of interest and consider whether independent

analysis is warranted.

Guidance-Issuer-Paid Research

Remember that this type of research is fraught with potential conflicts. Analysts'

compensation for preparing such research should be limited, and the preference is for a

flat fee, without regard to conclusions or the report's recommendations.

Guidance- Travel

Best practice is for analysts to pay for their own commercial travel when attending

information events or tours sponsored by the firm being analyzed.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Recommended Procedures for Compliance

• Protect the integrity of opinions-make sure they are unbiased.

• Create a restricted list and distribute only factual information about companies on

the list.

• Restrict special cost arrangements-pay for one's own commercial transportation

and hotel; limit use of corporate aircraft to cases in which commercial transportation

is not available.

• Limit gifts-token items only. Customary, business-related entertainment is okay

as long as its purpose is not to influence a member's professional independence or

objectivity. Firms should impose clear value limits on gifts.

• Restrict employee investments in equity IPOs and private placements. Require preapproval

of IPO purchases.

• Review procedures-have effective supervisory and review procedures.

• Firms should have formal written policies on independence and objectivity of

research.

• Firms should appoint a compliance officer and provide clear procedures for

employee reporting of unethical behavior and violations of applicable regulations.

Application o/Standard I(B) Independence and Objectivity

Example 1:

Steven Taylor, a mining analyst with Bronson Brokers, is invited by Precision Metals to

join a group of his peers in a tour of mining facilities in several western u.S. states. The

company arranges for chartered group flights from site to site and for accommodations

in Spartan Motels, the only chain with accommodations near the mines, for three nights.

Taylor allows Precision Metals to pick up his tab, as do the other analysts, with one

exception-John Adams, an employee of a large trust company who insists on following

his company's policy and paying for his hotel room himself.

Comment:

The policy of the company where Adams works complies closely with Standard I(B) by

avoiding even the appearance of a conflict of interest, but Taylor and the other analysts

were not necessarily violating Standard I(B). In general, when allowing companies to pay

for travel and/or accommodations under these circumstances, members and candidates

must use their judgment, keeping in mind that such arrangements must not impinge

on a member or candidate's independence and objectivity. In this example, the trip was

strictly for business and Taylor was not accepting irrelevant or lavish hospitality. The

itinerary required chartered flights, for which analysts were not expected to pay. The

accommodations were modest. These arrangements are not unusual and did not violate

Standard I(B) so long as Taylor's independence and objectivity were not compromised.

In the final analysis, members and candidates should consider both whether they can

remain objective and whether their integrity might be perceived by their clients to have

been compromised.

Example 2:

Walter Fritz is an equity analyst with Hilton Brokerage who covers the mining industry.

He has concluded that the stock of Metals & Mining is overpriced at its current level,

but he is concerned that a negative research report will hurt the good relationship

between Metals & Mining and the investment-banking division of his firm. In fact, a

senior manager of Hilton Brokerage has just sent him a copy of a proposal his firm has

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

made to Metals & Mining to underwrite a debt offering. Fritz needs to produce a report

right away and is concerned about issuing a less-than-favorable rating.

Comment:

Fritz's analysis of Metals & Mining must be objective and based solely on consideration

of company fundamentals. Any pressure from other divisions of his firm is inappropriate.

This conflict could have been eliminated if, in anticipation of the offering, Hilton

Brokerage had placed Metals & Mining on a restricted list for its sales force.

Example 3:

Tom Wayne is the investment manager of the Franklin City Employees Pension Plan.

He recently completed a successful search for firms to manage the foreign equity

allocation of the plan's diversified portfolio. He followed the plan's standard procedure

of seeking presentations from a number of qualified firms and recommended that his

board select Penguin Advisors because of its experience, well-defined investment strategy,

and performance record, which was compiled and verified in accordance with the

CFA Institute Global Investment Performance Standards. Following the plan selection

of Penguin, a reporter from the Franklin City Record called to ask if there was any

connection between the action and the fact that Penguin was one of the sponsors of an

"investment fact-finding trip to Asia" that Wayne made earlier in the year. The trip was

one of several conducted by the Pension Investment Academy, which had arranged the

itinerary of meetings with economic, government, and corporate officials in major cities

in several Asian countries. The Pension Investment Academy obtains support for the cost

of these trips from a number of investment managers, including Penguin Advisors; the

Academy then pays the travel expenses of the various pension plan managers on the trip

and provides all meals and accommodations. The president of Penguin Advisors was one

of the travelers on the trip.

Comment:

Although Wayne can probably put to good use the knowledge he gained from the trip

in selecting portfolio managers and in other areas of managing the pension plan, his

recommendation of Penguin Advisors may be tainted by the possible conflict incurred

when he participated in a trip paid for partly by Penguin Advisors and when he was in

the daily company of the president of Penguin Advisors. To avoid violating Standard

I(B), Wayne's basic expenses for travel and accommodations should have been paid

by his employer or the pension plan; contact with the president of Penguin Advisors

should have been limited to informational or educational events only; and the trip, the

organizer, and the sponsor should have been made a matter of public record. Even if his

actions were not in violation of Standard I(B), Wayne should have been sensitive to the

public perception of the trip when reported in the newspaper and the extent to which

the subjective elements of his decision might have been affected by the familiarity that

the daily contact of such a trip would encourage. This advantage would probably not be

shared by competing firms.

Example 4:

An analyst in the corporate finance department promises a client that her firm will

provide full research coverage of the issuing company after the offering.

Comment:

This is not a violation, but she cannot promise favorable research coverage. Research

must be objective and independent.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Example 5:

An employee's boss tells him to assume coverage of a stock and maintain a buy rating.

Comment:

Research opinions and recommendations must be objective and arrived at independently.

Following the boss's instructions would be a violation if the analyst determined a buy

• •• • ratIng ISmappropriate.

Example 6:

A money manager receives a gift of significant value from a client as a reward for good

performance over the prior period and informs her employer of the gift.

Comment:

No violation here because the gift is from a client and is not based on performance going

forward, but the gift must be disclosed to her employer. If the gift were contingent on

future performance, the money manager would have to obtain permission from her

employer. The reason for both the disclosure and permission requirements is that the

employer must ensure that the money manager does not give advantage to the client

giving or offering additional compensation, to the detriment of other clients.

Example 7:

An analyst enters into a contract to write a research report on a company, paid for

by that company, for a flat fee plus a bonus based on attracting new investors to the

• securIty.

Comment:

This is a violation because the compensation structure makes total compensation depend

on the conclusions of the report (a favorable report will attract investors and increase

compensation). Accepting the job for a flat fee that does not depend on the report's

conclusions or its impact on share price is permitted, with proper disclosure of the fact

that the report is funded by the subject company.

Example 8:

A trust manager at a bank selects mutual funds for client accounts based on the profits

from "service fees" paid to the bank by the mutual fund sponsor.

Comment:

This is a violation because the trust manager has allowed the fees to affect his objectivity.

Example 9:

An analyst performing sensitivity analysis for a security does not use only scenarios

consistent with recent trends and historical norms.

Comment:

This is a good thing and is not a violation.

Example 10

A member whose firm is seeking to become an investment manager for a labor union

contributes a large sum to the union leader's re-election campaign. After the union

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

hires the member's firm, the member continues to spend significant amounts on

entertainment for the union leader and his family.

Comment:

Offering gifts or other compensation to influence a decision to hire an investment

manager is a violation of Standard I (B).

Example 11

A member who is a performance analyst notices that one of her firm's top investment

managers has changed his composite construction, removing a poorly performing large

account and placing it in a different composite. Knowing that the investment manager

is important to the firm and a close friend of the firm's CEO, the member does not

disclose this change in her performance report.

Comment:

The member violated Standard I(B) by failing to exercise independence and objectivity

in her analysis. Altering composites to conceal poor performance also violates Standard

III (D) Performance Presentation and may violate Standard I(C) Misrepresentation.

I(C) Misrepresentation. Members and Candidates must not knowingly make any

misrepresentations relating to investment analysis, recommendations, actions, or other

professional activities.

Guidance

Trust is a foundation in the investment profession. Do not make any misrepresentations

or give false impressions. This includes oral, electronic, and social media

communications. Misrepresentations include guaranteeing investment performance

and plagiarism. Plagiarism encompasses using someone else's work (reports, forecasts,

models, ideas, charts, graphs, and spreadsheet models) without giving them credit.

Knowingly omitting information that could affect an investment decision or

performance evaluation is considered misrepresentation.

Models and analysis developed by others at a member's firm are the property of the firm

and can be used without attribution. A report written by another analyst employed by

the firm cannot be released as another analyst's work.

Recommended Procedures for Compliance

A good way to avoid misrepresentation is for firms to provide employees who deal with

clients or prospects a written list of the firm's available services and a description of the

firm's qualifications. Employee qualifications should be accurately presented as well.

To avoid plagiarism, maintain records of all materials used to generate reports or other

firm products and properly cite sources (quotes and summaries) in work products.

Information from recognized financial and statistical reporting services need not be

cited.

Members should encourage their firms to establish procedures for verifying marketing

claims of third parties whose information the firm provides to clients.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Application of Standard I(e) Misrepresentation

Example 1:

Anthony McGuire is an issuer-paid analyst hired by publicly traded companies to

electronically promote their stocks. McGuire creates a website that promotes his

research efforts as a seemingly independent analyst. McGuire posts a profile and a strong

buy recommendation for each company on the website, indicating that the stock is

expected to increase in value. He does not disclose the contractual relationships with the

companies he covers on his website, in the research reports he issues, or in the statements

he makes about the companies in Internet chat rooms.

Comment:

McGuire has violated Standard I(C) because the Internet site and e-rnails are misleading

to potential investors. Even if the recommendations are valid and supported with

thorough research, his omissions regarding the true relationship between himself and the

companies he covers constitute a misrepresentation. McGuire has also violated Standard

VI(A) Disclosure of Conflicts by not disclosing the existence of an arrangement with the

companies through which he receives compensation in exchange for his services.

Example 2:

Claude Browning, a quantitative analyst for Double Alpha, Inc., returns in great

excitement from a seminar. In that seminar, Jack Jorrely, a well-publicized quantitative

analyst at a national brokerage firm, discussed one of his new models in great detail,

and Browning is intrigued by the new concepts. He proceeds to test this model, making

some minor mechanical changes but retaining the concept, until he produces some

very positive results. Browning quickly announces to his supervisors at Double Alpha

that he has discovered a new model and that clients and prospective clients alike should

be informed of this positive finding as ongoing proof of Double Alpha's continuing

innovation and ability to add value.

Comment:

Although Browning tested Jorrely's model on his own and even slightly modified it, he

must still acknowledge the original source of the idea. Browning can certainly take credit

for the final, practical results; he can also support his conclusions with his own test. The

credit for the innovative thinking, however, must be awarded to Jorrely.

Example 3:

Paul Ostrowski runs a 2-person investment management firm. Ostrowski's firm

subscribes to a service from a large investment research firm that provides research

reports that can be repackaged by smaller firms for those firms' clients. Ostrowski's firm

distributes these reports to clients as its own work.

Comment:

Ostrowski can rely on third-party research that has a reasonable and adequate basis,

but he cannot imply that he is the author of the report. Otherwise, Ostrowski would

misrepresent the extent of his work in a way that would mislead the firm's clients or

prospective clients.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Example 4:

A member makes an error in preparing marketing materials and misstates the amount of

assets his firm has under management.

Comment:

The member must attempt to stop distribution of the erroneous material as soon as

the error is known. Simply making the error unintentionally is not a violation, but

continuing to distribute material known to contain a significant misstatement of fact

would be.

Example 5:

The marketing department states in sales literature that an analyst has received an MBA

degree, but he has not. The analyst and other members of the firm have distributed this

document for years.

Comment:

The analyst has violated the Standards, as he should have known of this

misrepresentation after having distributed and used the materials over a period of years.

Example 6:

A member describes an interest-only collateralized mortgage obligation as guaranteed by

the u.S. government because it is a claim against the cash flows of a pool of guaranteed

mortgages, although the payment stream and the market value of the security are not

guaranteed.

Comment:

This is a violation because of the misrepresentation.

Example 7:

A member describes a bank CD as "guaranteed."

Comment:

This is not a violation as long as the limits of the guarantee provided by the Federal

Deposit Insurance Corporation are not exceeded and the nature of the guarantee is

clearly explained to clients.

Example 8:

A member uses definitions he found online for such terms as variance and coefficient of

variation in preparing marketing material.

Comment:

Even though these are standard terms, using the work of others word-for-word is

plagiarism.

Example 9:

A candidate reads about a research paper in a financial publication and includes the

information in a research report, citing the original research report but not the financial

publication.

Study Session 1

Cross-Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Comment:

To the extent that the candidate used information and interpretation from the financial

publication without citing it, the candidate is in violation of the Standard. The

candidate should either obtain the report and reference it directly or, if he relies solely

on the financial publication, should cite both sources.

I(D) Misconduct. Members and Candidates must not engage in any professional

conduct involving dishonesty, fraud, or deceit or commit any act that reflects

adversely on their professional reputation, integrity, or competence.

Guidance

CFA Institute discourages unethical behavior in all aspects of members' and candidates'

lives. Do not abuse CFA Institute's Professional Conduct Program by seeking

enforcement of this Standard to settle personal, political, or other disputes that are not

related to professional ethics.

Recommended Procedures for Compliance

Firms are encouraged to adopt these policies and procedures:

• Develop and adopt a code of ethics and make clear that unethical behavior will not

be tolerated.

• Give employees a list of potential violations and sanctions, including dismissal.

• Check references of potential employees.

Application of Standard I(D) Misconduct

Example 1:

Simon Sasserman is a trust investment officer at a bank in a small affluent town. He

enjoys lunching every day with friends at the country club, where his clients have

observed him having numerous drinks. Back at work after lunch, he clearly is intoxicated

while making investment decisions. His colleagues make a point of handling any

business with Sasserman in the morning because they distrust his judgment after lunch.

Comment:

Sasserman's excessive drinking at lunch and subsequent intoxication at work constitute

a violation of Standard lCD) because this conduct has raised questions about his

professionalism and competence. His behavior thus reflects poorly on him, his employer,

and the investment industry.

Example 2:

Carmen Garcia manages a mutual fund dedicated to socially responsible investing. She is

also an environmental activist. As the result of her participation at nonviolent protests,

Garcia has been arrested on numerous occasions for trespassing on the property of a

large petrochemical plant that is accused of damaging the environment.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Comment:

Generally, Standard I(D) is not meant to cover legal transgressions resulting from acts

of civil disobedience in support of personal beliefs because such conduct does not reflect

poorly on the member or candidate's professional reputation, integrity, or competence.

Example 3:

A member intentionally includes a receipt that is not in his expenses for a company trip.

Comment:

Because this act involves deceit and fraud and reflects on the member's integrity and

honesty, it is a violation.

Example 4:

A member tells a client that he can get her a good deal on a car through his fatherin-

law, but instead gets her a poor deal and accepts part of the commission on the car

purchase.

Comment:

The member has been dishonest and misrepresented the facts of the situation and has,

therefore, violated the Standard.

II Integrity of Capital Markets

II (A) Material Nonpublic Information. Members and Candidates who possess

material nonpublic information that could affect the value of an investment must not

act or cause others to act on the information.

Guidance

Information is "material" if its disclosure would impact the price of a security or if

reasonable investors would want the information before making an investment decision.

Ambiguous information, as far as its likely effect on price, may not be considered

material. Information is "nonpublic" until it has been made available to the marketplace.

An analyst conference call is not public disclosure. Selectively disclosing information by

corporations creates the potential for insider-trading violations. The prohibition against

acting on material nonpublic information extends to mutual funds containing the

subject securities as well as related swaps and options contracts.

Some members and candidates may be involved in transactions during which they

receive material nonpublic information provided by firms (e.g., investment banking

transactions). Members and candidates may use the provided nonpublic information for

its intended purpose, but must not use the information for any other purpose unless it

becomes public information.

Study Session 1

Cross- Reference to CFA Institute Assigned Readings #1 & 2 - Standards of Practice Handbook

Guidance-Mosaic Theory

There is no violation when a perceptive analyst reaches an investment conclusion about

a corporate action or event through an analysis of public information together with

items of nonmaterial nonpublic information.

Guidance-Social Media

When gathering information from internet or social media sources, members and

candidates need to be aware that not all of it is considered public information. Members

and candidates should confirm that any material information they receive from these

sources is also available from public sources, such as company press releases or regulatory

filings.

Guidance-Industry Experts

Members and candidates may seek insight from individuals who have specialized

expertise in an industry. However, they may not act or cause others to act on any

material nonpublic information obtained from these experts until that information has

been publicly disseminated.

Recommended Procedures for Compliance

Make reasonable efforts to achieve public dissemination of the information. Encourage

firms to adopt procedures to prevent misuse of material non public information. Use a

"firewall" within the firm, with elements including:

• Substantial control of relevant interdepartmental communications, through a

clearance area such as the compliance or legal department.

• Review employee trades-maintain "watch," "restricted," and "rumor" lists.

• Monitor and restrict proprietary trading while a firm is in possession of material

nonpublic information.

Prohibition of all proprietary trading while a firm is in possession of material nonpublic

information may be inappropriate because it may send a signal to the market. In these

cases, firms should take the contra side of only unsolicited customer trades.

Application of Standard lI(A) Material Nonpublic Information

Example 1:

Samuel Peter, an analyst with Scotland and Pierce, Inc., is assisting his firm with a

secondary offering for Bright Ideas Lamp Company. Peter participates, via telephone

conference call, in a meeting with Scotland and Pierce investment-banking employees

and Bright Ideas' CEO. Peter is advised that the company's earnings projections for

the next year have significantly dropped. Throughout the telephone conference call,

several Scotland and Pierce salespeople and portfolio managers walk in and out of

Peter's office, where the telephone call is taking place. As a result, they are aware of the

drop in projected earnings for Bright Ideas. Before the conference call is concluded,

the salespeople trade the stock of the company on behalf of the firm's clients, and other

firm personnel trade the stock in a firm proprietary account and in employee personal

accounts.