www.gostudy.io Go Study’s CFA Exam Level ® 2016 Guided Notes Ethics by GoStudy™ www.gostudy.io Everything you need to pass & nothing you don’t www.gostudy.io Guided Notes for CFA® Level – 2016 Copyright © 2016 by Go Study LLC.® All Rights Reserved Published in 2016 The “CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute CFA Institute does not endorse, promote, review, or warrant the accuracy of the products or services offered by www.cfaexamlevel3.com Certain materials contained with this text are the copyrighted property of the CFA Institute The following is the copyright disclosure for those materials: “Copyright, 2016, CFA Institute Reproduced and republished from 2016 Learning Outcome Statements, Level III CFA® Program Materials, CFA Institute Standards of Professional Conduct, and CFA Institute’s Global Investment Performance Standards with permission from CFA Institute All rights reserved.” Disclaimer: These guided notes condense the original CFA Institute study material into 240 pages It is not designed to replace those notes, but to be used in conjunction with them While we believe we cover all of the core concepts accurately we cannot guarantee nor warrant that this is true Use of these notes is not a guarantee of exam success (although we think it will help a lot) and we cannot be held liable for your ultimate exam performance About gostudy.io Along with these Guided Notes, GoStudy offers a suite of products for in-depth exam strategies and comprehensive subject review to help candidates pass the final CFA exam We have hundreds of notecards and practice problems built into a mobile app for on-the-go review, with detailed analytics (coming), and last-minute cram material such as equation lists and “week before” summary sheets We also highly recommend candidates subscribe to our free newsletter for exclusive offers, access to study tips, tricks, and in-depth discussions of the exam We also periodically provide bonus resources such as mock exams, practice problems, and more to our subscribers If you have any questions regarding this product, the exam, or how we can help please contact us via the website We strive to answer every question a candidate has and are always incorporating Candidate feedback into what we build next www.gostudy.io Ethics (Study Session 1, Reading & 2) Ethics will show up in an afternoon selected response item set It will count for about 10-15% Having gone through Level and Level 2, you already know that Ethics is a unique section in that there is comparatively little to memorize For example, the CFA exam is not going to ask you to know what Standard I(a) is versus Standard II(b) by those names There will, however, be questions that ask you to choose which standard (or standards) is violated based on a passage and then list the different standards as the multiple choice options Past Level III exams have seen more questions on compliance, portfolio management, and the asset manager code of conduct than L1 and L2 Questions around suitability and fiduciary duty have been especially prominent, perhaps reflecting the core focus of L3 The bottom line: Basic knowledge is assumed, and it is probably worth at least one read through the Institute’s official ethics guide within a month or so of the exam, but for the most part you are better off doing lots of practice problems to get a feel for how to answer these questions That’s why we keep our overview of Ethics very high level and in outline form Basic Principles for Answering Ethics Questions Knowing which questions to ask when faced with an Ethics question can help you sort through the different options to arrive at the right answers Here are three key questions and two guidelines to help you: Questions All CFA Institute members and candidates are required to comply with the Code and Standards So …does the action uphold the profession? If you were the client would you agree with the course of action? Would a moral person, or leader, follow this course of action? Principles When in doubt err towards the more strict guideline/regulation There are differences between requirements as laid out in the Standards and recommended practice or guidance This distinction is often tested Ethics boils down to the golden rule How would you want your financial advisor to act? What actions should they take with respect to you and your portfolio? Chances are you’d want them to act in your interests and not those of someone else paying them You would want them to communicate what they’re doing and explain why, to be honest in reporting results, and to it frequently enough that you don’t worry about what’s going on Finally, an investment professional should also uphold the integrity of capital markets, (which you can think of as the greater good), even at their own expense.1 Always remember, there is a simple order of priority that should guide your actions—capital markets, clients, employer, then you Think Spiderman, with great power (you CFA Charterholder) comes great responsibility www.gostudy.io One Page Ethics Tear Sheet Summarizing the Code of Ethics -PEJMAR2 Priority - Your client's interests always come first (then your employer, then you) Encourage - Practice and encourage others to act professionally and ethically to reflect credit on yourself and the profession Judgment - Use reasonable care and judgment when performing all professional activities Maintain - Keep your knowledge up to date and encourage other professionals to the same Actions - Employ integrity, competence, diligence, and respect in an ethical manner with everyone Rules - Promote the integrity of capital markets by following the rules Standards of Professional Conduct Professionalism a Knowledge of the Law: Have to know them, comply with stricter of CFA, local, home law b Independence and Objectivity: Reasonable care, compensation ??s/issuer paid research c Misrepresentation: Knowingly misrepresenting/omitting information, commit plagiarism d Misconduct: Fraud, Negative light on profession Distinction btwn personal/professional Integrity of Capital Markets a Material nonpublic information: Can’t trade on it or cause others too MOSIAC theory b Market Manipulation: Artificially distort price or volume with intent to deceive Duties to Clients a Loyalty, prudence, and care: Act for benefit of client above employer/you Fiduciary duty b Fair Dealing: Fair and objective Disclose different levels of service (OK w/ no negative) c Suitability: In context of Risk constraints from IPS Evaluate on portfolio level vs risk of just security (prudent investor rule) d Performance and Presentation: Fair, accurate, fact vs opinion Recommend keep records for years e Preservation of Confidentiality: Always for past/present clients unless illegal, required, or for CFA institute investigation Duties to Employers a Loyalty: Employer before you Questions around quitting and taking client info/models often get tested b Additional Compensation Arrangements: Disclose first Written consent from all parties is required c Responsibilities of Supervisors: Reasonable effort to detect/disclose violations 2015 has moved to slightly more proactive duty to educate Investment Analysis, Recommendations, and Actions a Diligence and Reasonable Basis: Cover basis for investment, thorough, disagreeing on a group recommendation is OK b Communications with clients/ prospective clients: Would you want to know something if you were the client? If yes, then disclose it c Record retention: Electronic OR paper OK Recommendation: Keep records for years Conflicts of Interest a Disclosure of Conflicts: Disclose anything that would interfere with independence and objectivity b Priority of Transactions: Clients > Employers > You Treat paying family the same as other clients c Referral Fees: Full disclosure so clients can judge potential biases Often in SD context Responsibilities as a CFA Institute Member/Candidate a Conduct: Don’t cast negative light on profession or capital markets via your actions From http://www.investopedia.com/exam-guide/cfa-level-1/ethics-standards/code-ethics.asp and http://quizlet.com/3424974/cfa-ethics-code-and-standards-flash-cards/ Soft Dollar www.gostudy.io The Code of Ethics4 Investment professionals should act with integrity, competence, diligence, and respect They should convey their actions in an ethical manner to their clients, potential clients, and employers Investment professionals should place personal interests below the interest of clients and the integrity of the investment profession Investment professionals should act with care and maintain independent judgment when applying investment analysis, recommendations, and actions Analysts must use independent judgment when engaging in activities that will ultimately affect client interests Analysts should not only act in an ethical manner, but should promote ethical actions of others within the profession Investment professionals should contribute to well-functioning markets by respecting the applicable rules and promoting those rules to others Investment professionals should strive to maintain and improve their professional competence, as well as the competence of others within the investment profession Standard I: Professionalism Knowledge of the Law Keys: Know the rules Comply with the more strict law, regulation, or CFA standard Disassociate from any violations a You have to know, stay up-to-date and comply with the law No excuses Independence and Objectivity Keys: Reasonable Care and judgment, don’t accept compensation that can impact objectivity a Maintain independence and objectivity in all professional activities i No Gifts that can compromise even appearance of objectivity Modest gifts OK Gifts from clients are more OK than those seeking influence ii No invites to lavish entertainment/functions/tickets (often tests the distinction between lavish and reasonable accommodation to go research on a company) iii No favors/job referrals/or participation in oversubscribed IPOs iv Potential pressure from sell-side to have buy side issue favorable reports (Guidance: establish effective firewalls, restricted securities, limit gifts to nominal amounts) Note on Issuer Paid Research: Research must be thorough, unbiased, and independent The analyst must FULLY DISCLOSE conflicts and compensation structure A flat fee that is independent of the report’s conclusions is recommended but not required Misrepresentation a Must not knowingly give false impression in written, oral, advertising, or electronic communication This includes omitting facts b Must not misrepresent: i Credentials ii Services offered From CFA Institute Official Code of Ethics… www.gostudy.io iii Performance record iv Investment characteristics (or guarantee a return) v Plagiarism Cannot plagiarize Can use common sources like US treasury without attribution however (and this is commonly tested) Misconduct a Don’t it! Nothing dishonest, fraudulent, or with an adverse impact on profession or professional reputation Note the CFAI is very concerned with the !! Often test reputation of capital markets and its own self Anything that makes them look bad professional versus in a professional setting is probably a violation personal misconduct Standard II: Integrity of Capital Markets Material Nonpublic Information a If you have material nonpublic information (info that could affect an investment’s value) you CANNOT act or CAUSE ANOTHER to act on that information i Material: Material if disclosure would impact security price or is something a reasonable investor would want to know about the company ii Nonpublic until made available to entire marketplace (NOT just analysts) iii MOSIAC THEORY Mosaic theory involves collecting public and non-public nonmaterial information about a company in order to piece together a conclusion about its price If disparate sources of acceptable information lead to putting together the puzzle that’s ok That’s what analysts get paid to after all Market Manipulation a Do not artificially distort price or volume with an intent to mislead market participants including through releasing false information Variations of this are frequently tested Standard III: Duties to Clients Loyalty, Prudence, and Care Act with reasonable care and exercise prudent judgment Act for benefit of client, place employer interests ahead of your own Must comply with all fiduciary duties Fair Dealing Be fair and objective around analysis, recommendations, and professional activity i Service Levels: Different levels of service are OK but only if disclosed and !! If conflict does not disadvantage any clients EX: I can offer more research to a set exists between of clients that pay more, but I can’t release trade recommendations to written IPS and them earlier client wishes, ii Allow clients a fair chance to act on recommendations and notify them of follow IPS changes to recommendations before executing a client trade www.gostudy.io Suitability Know client’s Risk and Return (think IPS constraints) and take action consistent with those constraints Suitability is from a PORTFOLIO perspective not that of an individual security Invest to the fund mandate if managing a fund Performance Presentation Fair, accurate, and complete (will most likely be tested with GIPS not in Ethics) i Do not guarantee performance or misstate past performance Preservation of Confidentiality Keep Client (and former client) info confidential unless: i Illegal activities are suspected ii Disclosure is required by law iii Client or prospect allows disclosure Providing information to CFA Institute for investigation is not a violation of this standard Standard IV: Duties to Employers Loyalty Act for the benefit of the employer i If also practicing independently then written permission from employer is required ii When leaving employer Act in their best interest until gone Do not take records without permission (just knowing names and contacting once gone is OK) iii Whistle blowing: OK if it protects client or capital markets not OK for personal gain Additional compensation i No gifts/compensation that interfere with duty to employer or creates conflict of interest UNLESS written permission obtained from ALL parties (email is acceptable) Responsibilities of Supervisors Must make reasonable efforts to detect and prevent violations Standard V: Investment Analysis, Recommendations, and Actions Diligence and Reasonable Basis a Reasonable and adequate basis supported by research for analysis or recommendation i Cover all relevant issues and document when making investment Guidanc recommendation e ii Determine soundness of third-party research iii In groups, OK to disagree and not disassociate as long as basis is sound Communication with Clients and Prospective Clients www.gostudy.io Key: Would you want to know the information is the situation was reversed? If yes, then disclose a Disclose format and principals of investment processes & any changes to process b Include important factors for recommendations in communication (like basic characteristics of the security) c Distinguish clearly between fact and opinion Record Retention a Develop & maintain appropriate records with support for decisions (guidance is to keep years in either electronic or paper form) Records are firm property Standard VI: Conflicts of Interest Disclosure of Conflicts a Must make full, fair disclosure to clients, prospects, and/or employer on any matter that could reasonably be expected to interfere with independence or objectivity Disclosure is important to: i Allow clients to judge motives (e.g relationship with broker, stock ownership) ii So employers can judge any financial pressures that could influence your decision as an advisor (non-financial compensation is often referenced, it counts too) Priority of Transactions a Clients first, then employers, then and only then your transactions (no frontrunning) i Family member accounts with firm MUST be treated like any other account Giving worse treatment to family is a violation They are a client too Referral Fees a Disclose all fees so clients can evaluate full cost and potential biases Standard VII: Responsibilities of a CFA Institute Member or CFA Candidate Must not engage in any conduct that compromises reputation or integrity of CFA Institute or the CFA designation or exams a Cheating on exam, disregarding policies, giving confidential info away, improper use of CFA designation, misrepresenting the CFA program are all examples of such conduct Referring to the CFA Institute, Designation, or Program a Must not misrepresent or exaggerate the meaning or implications of membership i May reference participation but not a “partial designation” ii May say passed all on first attempt, but NOT indicate superior performance or ability because of this www.gostudy.io iii Chartered Financial Analyst and CFA marks always come after a charter holder’s name or are used as adjectives not nouns Want more notes? Get them plus a study app + mock exams and more www.gostudy.io Questions? Email vsowers@gostudy.io ...www .gostudy. io Guided Notes for CFA Level – 2016 Copyright © 2016 by Go Study LLC.® All Rights Reserved Published in 2016 The CFA and Chartered Financial Analyst® are trademarks owned by CFA. .. the CFA Institute The following is the copyright disclosure for those materials: “Copyright, 2016, CFA Institute Reproduced and republished from 2016 Learning Outcome Statements, Level III CFA ... http://www.investopedia.com/exam-guide /cfa- level- 1 /ethics- standards/code -ethics. asp and http://quizlet.com /34 24974 /cfa- ethics- code-and-standards-flash-cards/ Soft Dollar www .gostudy. io The Code of Ethics4 Investment professionals should